Flood Insurance schemes: Between risk reduction and risk business (the UK and the US)

Abstract:

For a long time, insurance has been considered an important risk mitigation mechanism, and an adaptation strategy of disaster events. It reduces the economic impacts of disasters and vulnerability successfully in the case of good regulations and policies atmosphere, captive by risk characteristics and the damage scale (OECD, 2014). This article engages a comparison between the British and the American flood insurance schemes against a frame of different criteria that include schemes' functioning mechanism, risk mitigation, and financial recovery. It focuses on the private sector as the main actor in the flood-risk recovery arena by rendering its form of evolvement. Moreover, it spotlights the role of governments’ intervention and regulations in achieving the risk reduction objectives, besides the importance of oversight of the private insurance market to prevent business of tragedies.

Introduction:

Flood insurance is a risk mitigation strategy based on transferring risk from one party to another in enter-change for an amount of payment known as “Premium”. Risks are deployed over space, time, and resources via insurance establishments that are responsible for providing compensation for recovery to victims. It can provide pricing for risks via many mechanisms meant to direct the individual behavior to avoid risk depending on risk assessment capacities (Krieger & Demeritt, 2015).

In theory, flood insurance helps in flood risk management and provides risk recovery, while at the same time can be a business of risk that makes revenues from others’ tragedies. The financial recovery and compensation approaches are different, some governments depend on taxes organized on a revised budget or ad hoc (Netherlands), others establish insurance agreements with premium potentiality under certain regulations (USA) and another approach is via the private insurance market (UK) where governments support this system via state-guaranteed reinsurance (Bougen, 2011) (CCP, 2021).

Insuring flood risk: the cases of the US and the UK

UK flood insurance:

Flooding is the most frequent natural disaster in the United Kingdom, its insurance scheme is distinct by being endorsed by the private sector only and private-public corporate agreements (Lamond, 2009) (Krieger & Demeritt, 2015). The scheme was triggered by the continuity of flood losses and grew as an investment over time. As a response, the “Gentleman’s agreement” was signed between the government and The Association of British Insurers (ABI), and was replaced formally by the Statement of Principle (SoP) that includes flood insurance in the standard policy of households and businesses which established before 2009 insignificant flood risk zones (AIB, 2021). The SOP removed a few informal pricing regulations, in return, the government commits to continue investing in flood risk reduction (Lamond, 2009). Recently, to increase system accessibility the scheme was reformed creating the Flood Re scheme in 2015 to operate temporarily (20 years) funded by tax and accompanied by a “Letter of Comfort” (Krieger & Demeritt, 2015)

United States of America flood insurance program:

In the late sixteenth the US. Congress created the” National Flood Insurance Program” (NIFP) to reduce flood damage (FEMA, 2021). It is based on community participation to obtain insurance protection via private insurers yet administrated by the government. However, it is limited to communities that adopt acceptable control measures by the Federal Emergency Management Agency (FEMA).The insurance purchase is mandatory to flood hazard areas, and premium values vary according to the Flood Insurance Rate Maps (FIRM) created by FEMA. Out of FEMA standards properties, those constructed before FIRMs have are included in pre-FIRM special subsidized premiums (OECD, Financial Managemen of Flood Risk, 2016) (GAO, 2014). The role of the private sector in NFIP appears in premiums payments and some other policies outsourced to private insurance companies, to whom losses are offset later by FEMA (GAO, 2014). The program was reformed to eliminate grandfathering of rates in 2012 called the Biggert-Waters Reform Act. Later in 2014, another reform was approved by the U.S Senate to (re-grandfathering) lower-rate increase of some subsidizing policies instead, this reform is called the Homeowner Flood Insurance Affordability Act of 2014 (OECD, 2016).

Risk mitigation, Risk Awareness, and Climate Change

Risk pricing in the UK during the SOP had high prices with high differences up to 200 BP (uncontrolled by SOP) (Krieger & Demeritt, 2015), risk reduction measures were not provided, however, the government is committed to increasing the restrictions of the planning rules and its flood-defense investments. Flood Re is similar to SOP yet, it exclusively addresses high-risk properties with price control, relying on the free private market to address other categories of risk properties (Krieger & Demeritt, 2015). However, the number of high-risk properties covered by Flood Re is expected to increase collectively due to climate change in the case of neglecting river and coastal protection and raising awareness according to DEFRA’s impact assessment on Flood Re in 2013 (CCCEP, 2021). Adding more, under Flood Re MoU raising public risk awareness is part of the government’s commitment to publish information regarding flood risks in addition to surface water maps, data, and combined maps. While the AIB commits to providing a national database of claims (Surminski & Eldridge, 2014) (FloodRe, 2020). 

The US is distinct in allocating more funds (ad hoc) to disaster response rather than risk mitigation, as evidenced by the government's annual average expenditures of around 3 billion USD on disaster response while only 195 million USD on risk mitigation, translated in this century to 87% (107 billion) as development assistance for disaster-related costs to 13% risk mitigation (OECD, Financial Managemen of Flood Risk, 2016). In the last 30 years, flood events became more frequent thus third of the cost of damage was caused by the accelerating risks of climate change (Frank, 2021) which turned-off private insurers and led FEMA to launch the RISK RATING 2.0 system that adopts the modern risk evaluation techniques based on the property level and charges higher premiums accordingly (Flavelle, 2021). To raise people’s awareness NFIP is offered in communities, in 1990 the government established a Community Rating System for communities to join voluntarily 68% of total policyholders while they represent 5% of total US communities (OECD, 2016).

Flood insurance vs. Development on Flood Plains

According to the UK scheme, newly built properties after 2009 are not applicable to insurance. Between the years 2001-2011, the development on flood plains decreased by 12% (ASC, 2012) (Surminski & Eldridge, 2014). Yet, 2000 new houses got granted for construction in flood-risk areas in Wales between 2016-2019 (Lloyd, 2021). Moreover, an American national study on flood mitigation via land-use strategy accredited the land-use strategy of avoiding flood plains development rather than the existing resist approach of flood mitigation (Brody & Highfield, 2013). 38% of claims are high-risk repetitive damage of properties, thus, some efforts have been carried out to address previous weaknesses such as the relocation buyout program in high-risk areas implemented by the state of New York, as it offered compensation to participating homeowners -on the Hurricane Sandy zone- the full pre-storm house market value (Kaplan, 2021). 

Financial Compensations and Recovery

Disaster finance is resorted to private insurers in the UK, the compensation performance is linked to insurance companies’ performance which average is 72% of all residential economic loss accounted for all years before 2015. During the previous decade, FloodRe remained to study options to discount premiums, enabling ‘Built Back Better’ reinstated by reinsurers and community activities (FloodRe, 2020). FloodRe’s performance enhanced over time, in 2020 the financial statement depicted 61 million BP of profits before taxes for 180 million BP income from levy, which makes FloodRe eligible for more available funds. On the assistance side, the British government in 2013 provided grants, tax relief, and improved access to bank loans to affected households and businesses as well (Krieger & Demeritt, 2015). Yet, still, business insurance against floods is a debate (Peachey, 2021) as it covers businesses differently creating a complex finance area (ABI, 2021). 

Regarding FEMA’s flood claims recovery, no records or specific studies were carried out to obtain the average annual coverage percentage and efficiency. However, taking the storm sandy case as an example to understand the recovery efficiency, according to the Government Accountability Office (GAO), many claims after Sandy storm remained unsolved three years after the storm, survivors raised around 1700 law-suits and 144,000 claimed reconsiderations which 80% returned more money to homeowners (CFA, 2021). Due to disaster seasons, NFIP is debited to the U.S treasury –the main funding source- with 1 million interest per day to 9.9 billion USD (CRS, 2021).

Governance and Profitability

In the UK, the FloodRe pool is a public policy intervention and an addition to the standard market. Insurers are authorized to draw terms, while the government monitors stakeholders, forms the rules of operation, and water utilities (Surminski & Eldridge,2014) The open insurance market stressed profitability due to an increase in competition, claims inflation, and weak pricing (IJ, 2021).

In contrast, the US flood program is accused to have outsized profits for private insurers who serve under the Write Your Won (WYO) contract with FEMA that excludes financial transparency. In the late nineties, GAO discovered that around 1-2/3 of premiums –around 1 billion USD- were returned to insurance companies (CFA, 2021). GAO analyzed some financial data from NFIP payments to WYO from reports prepared by the National Association of Insurance Commissioners, where the average pre-profits of WYO from 2011 to 2014 reached 317 million USA per year, that are 29% (Taddonio, 2021) of their received fees increasable in times of disasters! (Schwartz, “Business of Disaster”: Behind the Numbers, 2021). During an interview with Mr. Roy Right –FEMA Executive Officer- about flood-business he stated that profits were never looked at (Young, 2021). Also, companies modify the engineering assessment reports of property damages to reduce their recovery costs driving FEMA to allow reviewing refiled claims (Schwartz, 2021). The matter is under investigation, and WYO will be reformed (CFA, 2021).

Conclusion

In short, the UK struggled with risk pricing, FloodRe subsidizes policies for highest-risk properties to be affordable and increase public awareness. Whereas the US government allocated more funds to disaster responses instead of impact mitigation and linked the scheme participation to communities to increase awareness. Each scheme has a different risk financing approach, depending on premium subsidizing and grants provision of the British while land-use re-planning and post-disaster assistance are considered by the Americans. Climate change is affecting both schemes, either by increasing high-risk properties to be covered by Flood Re or by increasing damage costs and turnoff insurers to leave the burden to FEMA.

A lesson to learn is that Governments’ regulations and oversight of private insurers are vital to prohibit profiting from disasters and obtain efficiency, land-use planning is an effective risk mitigation strategy that should be better adapted, river and coastal protection must be considered, and risk mitigation insurance technologies impact on premium value requires further studies and payment policy development for more stakeholder’s inclusion.

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