Innovative flood reinsurance scheme is drawing criticism as well as praise

In the winter floods of 2013-14, following the wettest January on record, large tracts of the southern UK were inundated. Several low-lying rural areas remained under water for weeks, while some highly populated parts of the country were affected by swollen rivers and rising groundwater.

The threat of flooding in the UK is growing as weather patterns change and sea levels rise. Defra, the UK government's environment department, estimates that 5.8m properties - about 20 per cent of all homes - are at some risk.

Although the insurance industry has collectively agreed to provide universal cover for homes, under the existing system, known as the "statement of principles", premiums are not capped and therefore reflect the risk of flooding.

For owners of high-risk properties, defined by the Environment Agency as those facing at least a one-in-30 chance of flooding in any given year, policies can be prohibitively expensive.

To address this, in 2013 the government and the Association of British Insurers struck a deal to set up a flood reinsurance fund, Flood Re, aimed at extending affordable cover to the highest-risk homes. It follows the principle of Pool Re, a terrorism insurance fund which underpins UK commercial property insurance.

Insurers maintain their relationship with policyholders, but where insurers calculate that the flood risk element of a policy will exceed the capped premium, they can cede this to Flood Re.

In the event of flooding, Flood Re money will be used to reimburse insurers. While the not-for-profit scheme is ultimately backed by the UK government, it will be funded by premiums and a levy on every home insurance policy.

"What is unique about Flood Re is that if [flood] claims exceed reserves, it can make a secondary capital call to insurers," says Tony Sault, an executive director at EY.

Brendan McCafferty, chief executive of Flood Re, says Flood Re "fundamentally differs" from other pooled reinsurance schemes in that it covers attritional loss, in the form of annual floods, rather than just big events.

However, Flood Re is not intended to be a permanent feature of the UK insurance market, but a transitional arrangement set to last 25 years.

"It is designed to allow insurers to build flood risk pricing into their models, using more sophisticated mapping," says Mr Sault.

Mr McCafferty hopes the requirements for the subsidy will have diminished by 2040. "We need to eliminate the need for Flood Re at a causal level . . . [which] will only be successful if there is strategic flood defence."

Insurers and homeowners have complained that government spending on flood defences was cut by about a fifth between 2010-11 and 2013-14, with money allocated to repairing damaged infrastructure rather than invested in new defences.

Although Flood Re should reduce premiums for the vast majority of high-risk domestic properties, the scheme will not cover properties built since January 2009.

"This line was drawn with government, as we needed to make sure that there are no incentives for developments on flood plains," explains Mr McCafferty.

However, commercial insurance policies will be excluded from Flood Re, meaning that both leasehold and rental properties cannot be covered. According to the British Property Federation, which is concerned by these exclusions, 6.9m homes will be left outside the scope of Flood Re for buildings insurance as a result. Of the 800,000 leasehold properties - residential and commercial - at risk of flooding in the UK, 70,000 are classified as at high risk, says the Leasehold Knowledge Partnership.

Ian Fletcher, director of real estate policy at the BPF says that protests about these exclusions have fallen on deaf ears. "The government has said it will commission research into excluded groups, but this will only be reported after the legislation has come to pass. It's unsatisfactory."

Despite the exclusions, there have been calls for the scheme to be narrowed to lower its costs further.

In February, the chairman of the Committee on Climate Change, an independent adviser to the government, described Flood Re as "needlessly expensive" and recommended it be scaled back to offer taxpayers better value for money. Last year, the government estimated that the costs of implementing Flood Re would outweigh the benefits by three-to-one.

There are also concerns that the timescale for implementation is slipping. It was due to come into effect this summer, but Mr McCafferty says that testing of insurers' systems is now the priority. "It would be premature to say when we will launch," he adds.

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