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Who pays the ferryman? Floods are such frequent and potentially devastating natural events that in most countries the government has a major role alongside the commercial (re)insurance sector in managing the risk and compensating for losses. As highlighted in the previous chapter, the escalation of flood risk world-wide means that strategies for containing and managing its impact are becoming a higher priority. In the developing world, insurance is often beyond the reach of the majority and reliance on government and aid agencies remains the norm. In developed countries, as values at risk and the scale and frequency of flood events increase, how governments and (re)insurers respond to this exposure has become a high profile political issue. One of the most obvious responses is for government to increase the scope of flood protection measures. However, it could be argued that such action can actually increase flood risk by encouraging development in the protected zones. Successful flood defences mean that flooding of an exposed area becomes a rare event and perception of the risk is distorted. Property values accumulate and when an extreme event occurs and the flood protection fails, the resulting losses are many times more serious than would previously have been the case.1 The devastating floods which hit New Orleans after Hurricane Katrina in 2005 seem to bear out this theory. More than two years after the floods and after US tax-payers have already contributed USD127bn to rebuild the Gulf region, the debate as to whether and how much more to rebuild remains heated. USD6bn is being spent to upgrade the 350 miles of levees around New Orleans. But many observers argue that another Katrina-scale storm would still cause extensive damage to rebuilt properties, while investment in rebuilding will further increase values at risk. European pragmatism Elsewhere in the world, the question of whether and how much governments should intervene to provide flood protection has been no less urgent. Protecting against flood risk has been a fact of life for some European countries for centuries, but the issue came to the fore across the continent in 2002 when widespread floods caused economic losses of EUR18.5bn and insured losses in excess of EUR3bn.2 The relatively low proportion of the cost borne by commercial insurers and reinsurers reflects the fact that in many European countries flood damage does not form part of standard residential property insurance cover. In fact, most of the insured loss in this instance was borne by reinsurers on contracts written in Germany and the Czech Republic, followed by Austria and Italy. An exception to the European rule is the UK, which is generally regarded as the most comprehensively insured domestic flood exposure in Europe. Under the so-called “gentlemen’s agreement” with the UK Government, which has been in place for nearly 50 years, the UK insurance industry provides flood cover to virtually all residential properties, in return for government spending on flood prevention and mitigation measures. This allows a good spread of risk which means cheaper flood insurance for consumers, but the potential for substantial insurance losses is high. Thus the public/private question over flood risk management and the funding of losses is particularly acute in the UK. English gentlemen The “gentlemen’s agreement” has come under increasing strain in the wake of escalating flood losses since 1998, culminating in the summer of 2007 which cost the UK industry a record GBP3bn. In a recent report on coastal flooding, the Association of British Insurers (ABI) called for greatly increased spending on flood defences, arguing that the benefit to cost ratio of such investment is 7:1.3 The report suggests that given a sea level rise of 0.4m (which catastrophe models predict could occur as early as 2040), the number of properties at risk of flooding in eastern England would rise by nearly 50% to more than 400,000. With current sea defences, the cost of a single major coastal flooding event would rise to between GBP7.5bn and GBP16bn.4 Similar escalation in prospective losses is also predicted for other Western economies as suggested in Table 3.5 Table 3: Potential economic loss resulting from a major event (extensive failure of flood protection) Swiss Re
The ABI has also criticised Government proposals to locate some of its planned housing expansion on flood exposed areas such as the Thames Gateway, arguing that weather risks on insured property in the UK are already increasing by 2% to 4% per year as a result of the changing climate.6 However, some observers argue that the almost universal availability of flood insurance in the UK has already fuelled building on flood plains and other exposed sites where, without the “gentlemen’s agreement”, many properties would be uninsurable. Coastal attractions The record flood and windstorm losses caused by Hurricanes Katrina, Rita and Wilma in 2005 raised similar questions in the US regarding the inexorable development along the Atlantic and Gulf coasts. The population of the US has been migrating towards the coast for decades, and more than half the population lives within 50 miles of the sea.7 Since 1950 the number of people living in hurricane prone areas of the US coast has more than tripled to 34.6 million and even after the record hurricanes of 2005, some 1,000 people per day continue to move into the coastal hurricane zone.8, 9. This influx is reflected in the rapid appreciation of coastal property values, which have doubled over the last decade so that insured values for coastal properties along the East Coast and Gulf of Mexico now amount to more than USD7trn. In Florida, for example, 80% of the population of nearly 16 million live within ten miles of the coast and in 2004 property was worth USD1.2trn.10 The scale of loss caused by the hurricanes of 2005 prompted a re-evaluation of both the public and private provision of catastrophe cover in the US. Residential flood risk, including most water damage caused by coastal storms, is largely covered by the US Government National Flood Insurance Program (NFIP) established by Congress in 1968, while windstorm cover is generally provided by the commercial insurance market. Leaving aside the coverage uncertainties and disputes to which this dual provision gives rise, neither system was perceived to have performed well in the wake of the 2005 hurricanes. Despite a relatively low penetration rate (even in the highest risk flood zones, only about half of US homeowners buy flood insurance), aggregate flood losses to the NFIP following Hurricane Katrina were more than USD17bn, most of which was funded by loans from the Federal treasury.11, 12 As in the UK, it seems likely that the availability of insurance has helped to fuel the expansion of value at risk in coastal and other flood exposed areas. The NFIP provides coverage for vulnerable properties even if they have suffered multiple flood events. These so-called “repetitive loss properties” make up only 1% of the NFIP portfolio but account for 38% of total insured losses.13 Prior to the 2005 hurricanes, most coastal homeowners could also obtain windstorm insurance either in the commercial market or through government sponsored insurers such as Citizens in Florida. When premiums increased sharply post-Katrina as insurers and reinsurers re-evaluated the likely size and frequency of future hurricane losses, owners of high risk coastal properties saw windstorm cover become extremely expensive and difficult to obtain. Florida: rule change This became such an acute political issue in Florida that the state government approved various measures including a USD12bn expansion of the Florida Hurricane Catastrophe Fund (FHCF), which provides subsidised reinsurance to private insurers, to try to mitigate the higher cost of property insurance. Many observers saw this as a short term fix as it potentially shifted much more of the burden of future hurricane losses to the Florida tax-payer, given the gap between the FCHF’s assets of around USD2bn plus short term pre-event debt of USD6bn14, and coverage provided of USD28bn. Plans to mitigate tax-payers’ potential exposure by raising additional funds in the bond market met with limited success in 2007 and a net reduction in insurance costs of around 6% was also lower than the originally projected 24%.15 Yet despite its flaws, the Florida initiative prompted calls for Federal legislation regarding insurance coverage of coastal catastrophe exposures. Various proposals in 2007 included expansion of the NFIP to include wind damage, providing a Federal reinsurance scheme to provide excess of loss reinsurance for natural catastrophes, and changing the Federal tax code to allow insurance companies to avoid paying income tax on reserves for potential natural catastrophe losses. Caribbean initiative Another government initiative sparked by the KRW losses, although not targeted specifically at flood losses, shows an alternative approach to the public/private debate. The Caribbean Catastrophe Risk Insurance Fund (CCRIF) was formed in mid-2007 to provide immediate liquidity to Caribbean governments after a large catastrophe event. This World Bank sponsored project was the first time that a group of emerging countries had successfully sought disaster risk financing from the reinsurance industry. Aside from the provision of capital which reduces the need to accumulate large government-held reserves, the scheme benefits from reinsurers’ objective understanding of risk and helps to reduce the inefficiencies that may exist in traditional risk financing solutions. The scheme provides coverage both through traditional reinsurance markets and also as a catastrophe swap in the capital markets.16 Reality check Lobbyists from the insurance and reinsurance industry argue strongly that catastrophe (re)insurance can and should be left to the private sector, where risks can be researched, modelled and priced accurately. However, for properties in high risk areas, applying risk-based criteria to pricing and availability of insurance can have unwelcome economic and political repercussions. Ever-growing concentrations of risk in flood-prone areas in many developed countries and the huge economic implications of global warming suggest that whatever the political agenda, there will be continued need for the (re)insurance market to work alongside governments in addressing flood risk. Notes:
In reproducing this Highlight article we would like to acknowledge the whole team and writers at Benfield Research (www.benfieldgroup.com e-mail benfieldresearch@benfieldgroup.com telephone +44 (0)20 7522 4125) whose work we gratefully appreciate. If you would like Worldwide Risk Solutions to conduct an economic, business and insurance survey of any international markets please contact us – Details below. Worldwide Risk Solutions has access to a wide client base of internationally oriented organisations. Why not utilise this knowledge and experience? We can conduct a swift appraisal of your global activities or answer any questions you may have about international developments. Call +44 (0)1444 450 919 or send us an e-mail and we will respond immediately. And should you be passing through London, please let us know. For more information about any of the items discussed in the current or previous issues of WoRdS, please see our Contact Details George Worsley, Director |
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