Fit for Purpose and Fit for the Future? An Evaluation of the UK's New Flood Reinsurance Pool

• Published date: 01 March 2018
• Date: 01 March 2018
• DOI: http://doi.org/10.1111/rmir.12093

Risk Management and Insurance Review

C

Risk Management and Insurance Review, 2018, Vol.21, No. 1, 33-72

DOI: 10.1111/rmir.12093

PERSPECTIVE

FIT FOR PURPOSE AND FIT FOR THE FUTURE?AN

EVAL UA TI ON O F TH E UK’SNEW FLOOD REINSURANCE

POOL

Swenja Surminski

ABSTRACT

Flood Re is widely hailed as an innovative approach to disaster risk insurance.

This article offers a mixed-methods evaluation of the new pool, asking whether

it is “fit for purpose” and “fit for the future.” The investigation considers the

roles of the public and private sectors, risk modeling and risk communication,

technical underwriting, distributional aspects, and the behavioral implications

of Flood Re, particularly with regards to risk reduction and prevention. The

article concludes that the new pool is a transitional reinsurance arrangement

that supports the private insurance market and secures affordability of flood

insurance in the United Kingdom through premium subsidies. However, this

approach is likely to come under pressure in the face of rising flood risk as it

fails to incentivize flood risk management and risk reduction efforts.

INTRODUCTION

Natural disasters such as drought, flooding, and wind storms cause significant human

and economic losses, affecting communities, businesses, and governments and ham-

pering economic development and poverty reduction efforts. In many countries, such

disasters are becoming more likely with climate change according to projections by

the Intergovernmental Panel on Climate Change (“IPCC”). Moreover, the values at risk

are also becoming even greater due to increasing population concentration and rising

wealth, often in highly exposed coastal locations. These trends have reintensified discus-

sions among private insurers, governments, and international organizations about the

role of insurance in addressing disaster risks. The discourse follows two broad strands:

Swenja Surminski is at the Grantham Research Institute on Climate Change and the Environment,

London School of Economics. This article was prepared for the “Improving Disaster Financing:

Evaluating Policy Interventions in Disaster Insurance Markets” workshop held at Resources

for the Future on November 29–30, 2016. The author would like to thank the sponsors of this

project: the American Academy of Actuaries, the American Risk and Insurance Association, Risk

Management Solutions, the Society of Actuaries, and XL Catlin. The author also would like to

acknowledge the financial support of the UK Economic and Social Research Council (ESRC)

through the Centre for Climate Change Economics and Policy, and of the Grantham Foundation

for the Protection of the Environment through the Grantham Research Institute on Climate

Change and the Environment. The author thanks Joel Hankinson for his input and assistance.

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34 RISK MANAGEMENT AND INSURANCE REVIEW

reform of existing insurance schemes, such as in the United Kingdom and the United

States; and the design of new schemes in countries without disaster insurance, includ-

ing in developing countries (see, for example, Surminski and Oramas-Dorta, 2014). Such

efforts are based on the understanding that insurance mechanisms offer a more effective

way of addressing the costs of disasters than relying on postdisaster payments (see, for

example, Brainard, 2008; Hallegatte, 2014). The sharing of risks and the distribution of

the costs of compensation make insurance an attractive disaster response mechanism,

particularly for large catastrophic risks (Mechler et al., 2014), but remains underused in

many parts of the world.

In countries that have disaster insurance, this tends to be arranged through the state or

via a partnership approach between the public sector and private insurers, owing to the

complex nature of disaster risks. The affordability and availability of disaster insurance

can become a public policy goal, seeking to ensure that an economically efficient level

of insurance is provided and accessible to those who need it. However, in many cases,

governments face conflicting objectives and aims; in particular, being concerned with

reducing public expenditure on flood losses, but at the same time remaining keen to offer

a “helping hand” in times of flooding. If and how government intervenes in the flood

insurance market therefore depends, at least in part, on a country’s specific risk features,

cultural approach to solidarity and responsibility, political will, as well as recent loss

experiences (Kunreuther et al., 2009).

There are many different ways in which disaster risk insurance can be supported by the

government, ranging from direct premium subsidies to providing financial education.

Table1 shows how possible interventions can target the supply of insurance, the demand

for insurance, or premium levels.

The types of government intervention in disaster insurance markets vary significantly

between countries, ranging from no insurance, to only private or fully public insurance

(Paudel 2012; Lamond and Penning-Rowsell, 2014). For example, while French law re-

quires certain kinds of insurance contracts to cover natural catastrophes and fixes an

additional amount payable by the insured (Maccaferri et al., 2012), the U.K. government

has focused on making flood insurance more affordable by improving reinsurance op-

tions for insurers through its flood reinsurance program, “Flood Re.” While the former

can be considered a more “public” approach to flood insurance, the latter has continued

to rely predominantly on the private market.

One aspect that is growing in importance, but remains often overlooked in the public

policy discourse, is the suitability of insurance mechanisms to cope with changing

risk profiles. This is particularly relevant in the face of rising disaster costs due to

socioeconomic factors and climate change, which can pose a threat to future insurability.

These trends can negatively impact the business model of the insurance industry itself,

potentially making insurance unavailable or unaffordable. Currently, the industry’s best

defense against this is the 1-year contract relationship with clients, which does not require

an assessment of long-term risk, and offers flexibility to amend and adjust price coverage

on an annual basis. However, this is only a short-term defense against rising risk. If

significant efforts are not taken to reduce risk by increasing resilience,costs will continue

to rise and insurers may stop offering climate change-related insurance products, as

noted by the U.K.’s regulator PRA (Prudential Regulation Authority, 2015); indeed,

FIT FOR PURPOSE AND FIT FOR THE FUTURE 35

TABLE 1

Public Disaster Risk Insurance Interventions With the Aim of Increasing Take-Up of Insur-

ance

Target Area Intervention Measure

Supply Set-up state-owned insurer

Provide reinsurance

Provide capital

Pay operational costs

Provide product development expertise and technical support

Promote co-insurance pool

Link to social safety nets and credit facilities

Premium Levels Regulate premiums by setting limits or tariffs

Regulate risk models used

Data collection, audit, management and financing (can lead to higher

premiums)

Provide risk data to insurers (can also lead to higher premiums)

Reduce risk levels through better risk management

Demand Pay premiums in full or part

Offer vouchers for insurance

Offer incentives for insurance

Mandate insurance

Provide risk data / awareness campaigns

Financial education

Promote enabling environment via legal framework and consumer protection

Source: Vivid Economics et al., 2016.

adaptation could feasibly become a prerequisite to receiving insurance (Golnaraghi

et al., 2016).

Purchasing an insurance product can influence the behavior of those at risk. This can

either be in a moral hazard1context, where insurance can lead to more risky behavior,

or as an incentive, where insurance can trigger risk reduction investments or the im-

plementation of prevention measures (see, for example, Kunreuther, 1996; Kunreuther

and Michel-Kerjan, 2009). Despite a renewed interest in risk reduction by policymakers

1Moral hazard occurs when a member of the party acts conversely to the principles set out in

an agreement between those parties. For example, in an insurance contract, the individuals’

motives and behaviour to prevent loss may be reduced if financially protected through a policy,

thus resulting in an increased probability of loss. For more detail on moral hazard, please see

Arrow (1968) and Pauly (1968). This can affect governments, wherethe existence of an insurance

scheme may reduce the urgency to prevent and reduce risks, or at the insured level, where the

purchase of insurance may lead to a false sense of security.