Flood Re is only a temporary solution, warns Fitch

Flood Re, the UK Government's scheme to pool flood risk will not reduce flood risk in the long term, despite making home insurance temporarily affordable for policyholders, according to a new report by Fitch Ratings.

Fitch said that Flood Re does not bind the government or policyholders to reduce the risk of flooding at either the community or property level.

Government investment in flood defences is outside the Flood Re framework and subject to political will and budget constraints beyond the current five-year programme, said the report.

Fitch believes that by making home insurance affordable, Flood Re reduces the financial incentive for policyholders to make flood-resilience improvements to their properties and for the government to invest in flood defences. Resistance measures reduce the chance of a property flooding and include external barriers, water-resistant doors/windows, and airbrick covers.

Resilience measures reduce the damage when a property floods and include water-compatible internal walls and flooring, pumps and raised electrics and appliances.

Households priced out of the insurance market would have a stronger incentive to reduce the damage caused by flooding through resistance and resilience measures, said Fitch. Flood Re removes this financial incentive because home owners would be able to claim back the cost of any damage, reducing the economic opportunity cost for not making property improvements.

The Statement of Principles (SoP), an informal agreement between government and the insurance industry prior to Flood Re, included a clearer requirement for government investment. Home insurers agreed under the SoP to include flood insurance coverage as standard in home insurance policies, albeit at sometimes unaffordable prices. The industry only agreed to include this cover for homes for which flood defences were already in place, or would be in place within five years. Flood Re, on the other hand, will provide coverage regardless of any action or inaction from government.

Flood Re begins in April 2016 and will be funded by an industry levy of £180 million, which is expected to be passed on to policyholders at £10.50 per policy on average. Insurance companies will then be able to pass on flood risk through the purchase of subsidised reinsurance from Flood Re.

The scheme is intended as a transitory measure and will be gradually phased out with an expiration date of 2039.

Fitch said Flood Re will have a limited impact on the ratings of UK non-life insurance companies due to their size and business/geographic diversification. Companies will benefit from an increase in the number of potential customers and from access to a nationally aggregated flood risk database.

The scheme's ultimate goal is for the insurance industry to return to risk-reflective pricing at the expiry of Flood Re without the current issue of flood cover being unaffordable for many households. Achieving this goal will require large-scale improvements in flood defence and resilience measures.

Chancellor George Osbourne also announced additional funds for flood defence investment in his 2016/2017 budget. The £700 million commitment will be funded by a 0.5 percent rise in the Insurance Premium Tax (IPT).