In my last post, we saw that the insurance industry has broken with the status quo because it realises that flood risk has entered into a new era. The stable frequency and loss distributions that underpinned their actuary-led calculations of the past are no more. The loss-related data that the industry laboriously collected in the past only gives insurers a limited ability to look into the future.
Nonetheless, if we only think of the pure insurance risk (as opposed to an insurer’s business model risk), insurance companies are really looking out only one year: when a home owner’s policy comes up for renewal each year, the insurer has the opportunity to change the terms and conditions of the policy including the premium and excess. And they could change the terms and conditions very aggressively—the equivalent of suspending coverage, just in disguise.
Given these factors, if an insurer can look out for that one year and capture a decent understanding of the risk, it should be protected from any massive loss event that blows it out of business. And if there is a big loss event and the insurance company is still standing, it can subsequently change the terms and conditions of the outstanding policies at the next yearly renewal including a hefty hike in the premiums.
Up until the floods of 2007, with their £3 billion-plus associated insurance pay-outs, the information in the hands of an insurer and a well-informed home owner would have not been that much different. Both would have had access (and still do have access) to the Environment Agency (EA)’s flood maps.
The flood maps are updated quarterly and give a risk assessment at the one in 100 and one in 1000 flood probability levels for river flooding (an EA pamphlet on the flood map can be found here). On top of this, the EA provides the insurance industry with the National Flood Risk Assessment (NaFRA) data. As mentioned in a previous post, this is more specific in terms of its flood risk categories (an EA pamphlet on NaFRA can be found here) and underpins the Statement of Principles agreement between the Association of British Insurers and the government. I will repeat the risk category definitions once again:
- Low risk: the chance of flooding each year is 0.5 per cent (1 in 200) or less
- Moderate risk: the chance of flooding in any year is 1.3 per cent (1 in 75) or less but greater than 0.5 per cent (1 in 200)
- Significant risk: the chance of flooding in any year is greater than 1.3 per cent (1 in 75)
A home owner may have more interest in the one-in-75 risk (available from NaFRA) rather than the one-in-100 risk (available from the EA on-line Flood Map) since this is the demarcation point used to differentiate between ‘significant’ risk and ‘moderate’ risk, and as a result drives insurance premiums levels. Moreover, this risk demarcation point gives an some indication of what ‘significant’ risk property owners may be in for after the expiry of the Statement of Principles agreement expires in June 2013. Continue reading