Wednesday19 February 2020 ★ FINANCIAL TIMES 7

FT BIG READ. ENVIRONMENT

Floods were once considered too irregular to insure against profitably. Global warming and technology

have triggered a change of mind. But who should pay for it — governments, industry or households?

By Robert Armstrong and Oliver Ralph

encourageinfrastructure investment.

Many also believethat private insur-

ance — the free market — offers the best

pricing mechanism.

Yet there is a reason that, as Whar-

ton’s Ms Kousky says, “there is almost

nowhere in the world with a fully pri-

vate disaster insurance market”. Floods,

she says, “are concentrated and corre-

lated risks... you have lots of quiet

years and then a really bad year”. This

requires insurers to hold lots of capital,

and therefore charge high premiums.

In some areas high premiums would

bring down the prices of prime real

estate. In others, they would force out

low-income residents. The political bar-

riers to eitherare high.

Barry Gilway,chief executive of Citi-

zens, a Florida-based property insurer,

uses the example ofFlorida Keys.

“Without subsidisation no homeowner

could really afford to live or build in

Monroe County due to the extremely

high costs of funding the risk.

“After Hurricane Irma [in 2017] they

had to rebuild to new building codes.

While absolutely appropriate, that is

very expensive. With no afforda-

ble housing and extremely high

insurance costs, where do all

the people in the service

industry live?”

A few steps would make the

public-private balance easier

to achieve. Investment in

detailed public flood maps would

also helpincrease risk awareness and

improve underwriting.

The First Street Foundation, a non-

profit group,has begun work on this in

the US, but publicinvestment is

required.“We need an atlas of flooding,”

says Stijn Van Nieuwerburgh, a prop-

erty economist at Columbia University.

Ms Kousky of Wharton recommends

a system modelled on the way terrorism

is insured in the US: a private market

with insurers backstopped by the gov-

ernment.

“We want to have some amount of

risk-based pricing [but] that’s perfectly

do-able even with a government back-

stop at a very high level,” she says.

Following the example of the UK, new

buildings could be excluded from sub-

sidy programmes. Alternatively, people

could be given help to make their homes

more resilient, so that future floods

cause less damage and cost less to repair.

Flood Re wants to be able to covervic-

tims not just for the costs of repairing

damage but also to “build back better”.

“Flood risk management cannot be

done by the insurance industry alone,”

says Konrad Schoeck, a flooding special-

ist at reinsurance group Swiss Re. “It

needs to be the insurance industry, the

government and private homeowners.”

It may be that the suffering caused by

flooding is not yet enough to force hard

choices. But with waters continuing to

rise that is unlikely to remain the case.

“As levels of risk rise, there will be

more questions about uninsurability

and what you do about it,” says Arno

Hilberts, vice-president at risk model-

ling company RMS. “You will reacha

threshold where insurance systems

don’t really work.”

While wealthy countries such as the

US and UK struggle to decide which

climate change risksthe state should

carry, the calculus for poor or middle-

income countries is very different.

Avoiding the worst impact of floods

will cost billions.In Indonesia, Jakarta

is slowly sinking, which last year led

President Joko Widodo toannounce

plansfor a new capitalonBorneo.

Even where the problems are not so

eye-catching, there is often little

private insurance in place to

cover the growing flood risk

as few people can afford it.

But there is a role for

insurers. One is to help

countriesfinance the cost

of dealing with floods via

so-called parametric

insurance policies sold to aid

agencies or governments. These

policies pay out as soon as a

threshold, such as the depth of a flood,

is breached.

Flood funding

‘Only thing worse than no

insurance is bad insurance’

O

n November 8,Pam Webb

workeda usual day at

Truffle Lodge, her spa

business in the Yorkshire

village ofFishlake, near

the River Don. Floods were expected

nearby, but an email from the UK’s

Environment Agency told her that Fish-

lake was safe.

The agencywas wrong. At 9.30pmthe

water started pouringinto the business

and Ms Webb’s home next door.“It

came in the front and back, it came up

through the flooring in every single

ground floor room,” she says.“It’s

heartbreaking seeing your home and

business going in such a small amount of

time.”

The flood caused tens of thousands of

pounds in damage and forced the spa to

close for nine weeks.Adding to the

trauma, says Ms Webb,flooding had

beenexcluded from herinsurancepoli-

cies about a year earlier, so shehas had

to pick up the entire cost.

It is a scenario that has played out

again acrossparts of the UKover the

past 10 days, with two severe storms hit-

ting the country and adding to the cost

associated with climate change.Eco-

nomic damageworldwide from flooding

last year was $82bn, the greatest of any

natural peril, according to Aon. Just

$13bn of that was insured.

Global warming means that flooding

is likely to become more frequent, say

natural catastrophe modelling special-

ists. Warmer air holds more moisture,

leading to wetter and more frequent

severe storms. Last year,Nasa used tem-

perature data gathered from space, to

revealthat every additional 1C of ocean

surface temperature increases the prob-

ability of severe storms by 20 per cent.

Meanwhile,rising sea levelsmean more

coastal flooding, with some estimates

suggesting that 230m people are at risk

from storm surges, a riskamplified by

steady migration towards conurbations

near coasts and rivers.

Those numbers, combined with the

lack of cover,should be an attractive

target for a global insurance industry

that hasabundantcapital after low

interest rates drew fresh investors seek-

ing better returns into the sector. The

risk consultancy Milliman estimates

that the US market alone could generate

$48bn of annual premium revenue for

insurers.

Floods were once considered too

irregular to underwrite profitably, but

sophisticated catastrophemodels —

which can more accurately predict

where floods might occur —have

changed that.

“Reinsurance companies want

the risk,” says Nancy Watkins,

principal and actuary at Milli-

man. “They have been the

leaders, and have been run-

ning around trying to sell

[flood reinsurance] for four or

five years.”

Yet, managing the increased

flooding is going to be very expensive.

Insurance systems and government

programmes have developed haphaz-

ardly, and are ill-suited to deal with the

growing risks. This is prompting a

have averaged $3.5bn a year. Premiums

and fees have been inadequate to cover

the payouts. In 2017, the federal

government forgave $16bn in

NFIP debt. Even so, the

schemeowes $20bn to the

US Treasury.

That mandatory cover-

age areas are too small is

only part of the problem, say

critics. They also give the

impression that flood risk stops

at a line on a map. In fact, “flood risk

varies continuously both within that

100-year floodplain and beyond”, says

Carolyn Kousky, executive director of

the Wharton Risk Center.Flood risk is

not included in US home insurance poli-

cies, creating the impression, say flood

experts, that the risk is incidental or sec-

ondary.

These are not the only distortions.

NFIP charges premiums that do not

vary with the replacement cost of

houses, so expensive houses pay below-

market rates. It means taxpayers are

effectively providing subsidies for lux-

ury beach houses. “The more expensive

your house, the better deal you are get-

ting from the NFIP,” Ms Watkins says.

The NFIP is not permitted to with-

draw coverage once it is granted, sopays

repeatedly to repair and rebuild thou-

sands of homes in high-risk areas.

According to Pew Charitable Trust, such

“severe repetitive loss” propertiescost

the NFIP more than $12.5bn up to2016.

Private insurers hesitate to compete

against a subsidised product. A warren

of state regulations makes matters

worse. In Louisiana, for example, rais-

ing premiums because of an“act of God”

— defined as a storm or other natural

cause — is forbidden. Several US states

banor limit the use of catastrophemod-

els in setting premiums.

Various attemptsto reform the NFIP

andbring premiums into line with the

risks have met resistance from coastal

residents, their representatives in Con-

gressand the real estate industry. The

latest effort, “Risk Rating 2.0”, would

have linked prices and risk more closely.

Originally scheduled to take effect this

year, it was recently pushed into 2021.

Industry-led initiative

TheUKhas tried a different model.

Flood Re, the UK scheme, forces all

home insurance buyers to chip in to sub-

sidise the cost of cover in flood-prone

areas. Homeowners payabout £10 a

year over their existing premium and, in

theory, insurance for people in risky

areas becomesmore affordable.

Flood Re was set up by the govern-

ment in 2016. If it runs out of money, the

industry has to top it up, but that has not

happened yet. “The political desire at

the time [it was set up] was for it to be an

industry-owned solution,” says Andy

Bord, Flood Re’s chief executive. To dis-

courage new development in flood

prone areas, Flood Re does not apply to

homes built after 2009.

Flood Re is only supposed to last for

25 years. The intention was that it

should act as a catalyst forbetterflood

planningby the government, local

authorities and homeowners, so that by

2039 insurance would be more afforda-

ble for people in vulnerable areas, even

without the subsidy.

There isscepticism in the industry

about whether this is achievable. But Mr

Bord says “four out of five people [in

flood prone areas] have made a saving of

50 per cent or more on their home

insurance”. China and Australia are

among the countries interested in

developing a similar scheme and have

asked Flood Re for details of how it

works.

Flood Re has yetto be fully tested. The

years since 2016have been relatively

quietfor UK floods, althoughrecent

eventssuch as Fishlakemay prove a

more rigoroustest.It has only

dealt with 1,100 claims in

total since it was set up, Mr

Bord told the Financial

Times in January, far

short of initial expecta-

tions that it woulddeal

with 2,000 a year.

But they have to avoid

complacency, says Mr Bord.

“People are taking action, but not

fast enough,” he says. “If you haven’t

been flooded, you think it can’t happen

to you. If you have, you think it won’t

happen again.”

The insurability question

Flood experts agree that, in relatively

wealthy countries, the price of living

near the water must better reflect the

risks, to both stop overbuildingand

The Centre for Disaster Protection

funded by the UK government has just

been set up in London to help

countries understand how insurance

or other forms of financing could help.

“There is a challenge in the way the

world pays for disasters, waiting for

them to happen and then paying for

them, rather than preparing in

advance,” says Daniel Clarke, the

centre’s director. Insurance can help

but it has to be tailored to cover the

right risks. “The only thing worse than

no insurance is bad insurance that

people rely on and then it doesn’t

come through.”

One of the challenges is to get three

very disparate groups — insurance

companies, governments and aid

agencies — to work together.

“The consequences of the climate

crisis such as repeated flooding is

ultimately a humanitarian issue. But

it’s not one that the public sector and

charities can solve on their own — we

need to collaborate with commercial

partners,” says Simon Meldrum, a

formerbanker who is now an

investment specialist with the British

Red Cross.Oliver Ralph

Sources: Aon







Average -





    

Source: NFIP

Most flooding losses are not

insured

America’s costly flood bill

Losses in bn (adjusted for inflation to

 US dollars) for floods worldwide

Claims paid by the National Flood

Insurance Program (bn)

















    

UnInsured

Insured

rethink overwhich risks should be held

publicly, and which privately.

“The world has got enough

insurance capital to protect

against flood risk,” says

Stephen Hester, chief exec-

utive of insurer RSA.“It’s a

question of whether soci-

ety wants people who live

on flood plains to pay the

right price for the risk, or

whether there should be some

sort of subsidy.”

Access to cover

In the US theNational Flood Insurance

Program, the federal schemethat pro-

vides the overwhelming majority of US

residential coverage, has about 5mpoli-

cies providing $1.3tn of cover. The num-

bers look large, but only 15 per cent of

US households have any flood coverage

at all. During 2017’sHurricane Harvey

that hit Texas and Louisiana, 70 per cent

of theestimated $125bnin damage was

uninsured.

Flood insurance is mandatory for

anyone in the US with a government-

backed mortgage — that is, most US

homeowners — if the home falls into a

designated “special flood hazard area”,

defined as being at risk of inundation at

least onceevery 100years.

But the NFIP, established in 1968, was

never designed or capitalised to operate

like a private insurer. The idea “was to

price the product so more people would

have it andit would [then] reduce the

disaster costs to the government”, says

David Maurstad, chief executive of the

NFIP. By design, “the government

would make up the difference” in

above-average years for flooding.

This arrangement worked until about

20 years ago. Between 1978 and 2003,

the NFIP paid out claims ofunder

$500m a year. Since then, the claims

Floods ‘are concentrated

and correlated risks

... you have lots of

quiet years and then a

really bad year’

Covering the climate change bill

$3.5bn

Average annual cost of

claims paid by the US

National Flood

Insurance Program

since 2003

230m

People around the

globe at risk from

storm surges — about

3% of the population

A rescue worker wades through

floodwaters in Tenbury Wells,

western England, on Sunday.

Storm Dennis caused flooding and

power outages across large swaths

of Britain and northern Europe

Oli Scarff/AFP/Getty

Top, flooding caused by Hurricane

Harvey in Houston, 2017. Above,

floods in São Paulo last week

Getty Images; Shutterstock

70%

Of the estimated

$125bn in damage

caused by Hurricane

Harvey was uninsured

FEBRUARY 19 2020 Section:Features Time: 18/2/2020-18:39 User:charlotte.middlehurst Page Name:BIG PAGE, Part,Page,Edition:USA, 7 , 1