In autumn 2000, inland flooding occurred in some 700 locations across England and Wales, causing damage to about 10,000 properties and insured losses of £1.3billion (36).

The June and July floods of 2007 had an enormous impact of on Britain's insurers. The scale of the flooding across the UK was massive, exceeding all events since flood cover was introduced as a standard feature of property policies in the early 1960s. The industry has responded to around 165,000 claims, with around 120,000 household claims, 27,000 commercial claims and 18,000 motor claims, and was to pay out approximately £3 billion. With the average cost of a property flood claim running at £20,000. These floods were the largest natural catastrophe insurance loss ever recorded in the UK. The full economic and social cost is likely to be many times higher, with thousands of people having to leave their homes, schools unable to open, companies unable to function and families having to move into temporary accommodation (5)

The potential influence of major flood events in England and Wales is substantial, as currently 4–5 million people and 1.8 million properties are at risk of fluvial and coastal flooding (6), as well as an additional 80,000 properties at risk of intra urban flooding (7). The total value of these assets at risk is estimated at £222 billion, with approximately £110 billion of assets lying within the Thames region (8). Additionally it is projected that the total economic risk due to flooding will increase by up to 20 fold by the 2080s (9).

A research report produced by the ABI in 2006, ‘Coastal Flood Risk – Thinking for Tomorrow, Acting Today’ revealed that a rise in sea level of 0.4m, which is highly likely by the end of this century and could happen as early as 2040, could, unless the level of protection provided by the existing coastal defences were enhanced, raise the financial cost of a major coastal flood in South East England to as much as £16 billion (10).

Work in Scotland (11)suggests that frequencies for the 1 in 100 year events would increase to 1 in 10 or 20 years by the 2050s under the same scenario. Such coastal flooding events could increase the cost of insurance claims in the UK from £5 billion to £40 billion by the 2050s (12) if London was also affected.

This approach is unusual in not passing all or part of the flood risk to Government schemes. At present, the situation in the UK is based on an informal agreement established between the insurance industry and the Government in the 1960s and reaffirmed in a recent Statement of Principles. As a result of this informal agreement, flood risk is included in private household and contents insurance with the Government providing flood defences in those areas deemed at risk from coastal or river flooding. The importance of insurance lies in the ability to minimise financial and social disruption from flood events quickly and effectively, resulting in a successful return to a safe environment and living conditions (13).

In 2002, the insurance industry agreed a statement of principles on flood cover with the Government. The insurance industry agreed to continue to provide flood cover as a standard feature of household and small business policies where the risk of flooding was no greater than one in 75 years. In return, the Government agreed to a set of actions intended to minimise the number of households and small businesses that would not be eligible for cover under this commitment (5).

The Association of British Insurers and its members agreed with Government to continue to provide insurance cover in most cases until at least June 2013 (14), for any existing property subject to annual inundation probability no greater than 1.3% (41). Where the protection was currently less than this, but defence improvements were planned, cover would remain available for five years. Where no defences were planned, the insurers would not guarantee to maintain cover, and any cover offered may be priced to reflect a property’s exposure. However, the agreement states that insurers would work with owners to see what action could be taken (by the owner, local authority or Environment Agency) to improve the insurability of the property (41). After the 2007 flood, the ABI stated that a 0.5% annual probability would be the minimum level of flood protection required to enable insurers to make cover readily available for residential properties built from 2009 (42).

Insufficient flood specific planning and development control in the past combined with increases in the value of assets at risk within the area have exacerbated the consequences of flooding. As a result concern has risen in the UK insurance industry that the financial risk in such areas may not be able to be managed affordably (13).

It seems unlikely that many defences with a 200 year standard of protection will be eligible for grand aid in the future, and cheaper defences with a much lower standard of protection will be the norm. The Association of British Insurers emphasizes the need for a 200-year standard of protection if insurance is to be available at normal terms. Crichton (1) states that insurance and mortgage problems, even if confined to only a small proportion of houses, could burst the bubble. Planners are still allowed to build houses even where the flood hazard is more frequent than 1 in 100 per year, if there is nowhere else to build. Withdrawal of insurance would have a number of serious problems for society: property values would reduce, and in some cases mortgages might be foreclosed leading to blight; society has become dependent on the insurance industry to help it to recover from flooding, not only with claim payments, but also the ability of insurance loss adjusters to mobilize repair and restoration specialist companies, and provide alternative accommodation.

According to National Land Use Change Statistics, 591,566 new houses were built in England between 1995 and 1999. Of those, more than 10% were built in the floodplain. Currently 27% by value of new properties are now being built in floodplains against the advice of the Environment Agency (16). So it is clear that the planning community in England and Wales are often quite happy to ignore the advice of the Environment Agency, and allow developments to proceed in flood hazard areas despite the risks, and despite the legal consequences of possible lawsuits by flood victims (1).

Many of the areas identified by the Government for planned housing growth, as laid out in the Sustainable Communities Plan (17), lie within floodplain land, especially in the Thames Gateway. Although recent flood events have heightened public awareness of the risk of living in such areas, governmental targets cannot be met by local planners unless the floodplain is used as an option (1). This is a particular problem in the South East of England, where land is at a premium in terms of both cost and availability (13).

Insurance coverage is not mandatory, leading to a higher level of uninsured clients among poor households (52).

Most Scottish local authorities will not allow new housing to be built in areas where the flood hazard is unacceptable to insurers. The irony is that it is despite what has been achieved already in Scotland to manage flood hazards, continuation of flood insurance in Scotland and Wales appears to be entirely dependent on what happens in England.

The standard of protection varies in between 1,000 years for sheltered housing, and homes for the disabled and elderly, via 750 years for children’s homes, boarding schools, hotels, via 500 years for bungalows without escape skylights and ground floor flats to 200 years for other residential property.

According to Crichton (1) Scotland is better prepared for flooding. The action taken since the floods of 1993 and 1994 in Scotland, and particularly since Devolution in April 1999, makes Scotland a better flood insurance risk than England and Wales. There are a number of reasons why the position in Scotland is very different from England and Wales:

• smaller population at risk: in England and Wales there were some 907,000 residential and non-residential properties in the inland floodplain in 2003, already 12 times higher than the corresponding Scottish figure of 74,700 such properties (18). These figures do not include properties at risk of coastal floods: there are no accurate figures for these in the public domain.
• the Scottish figure for properties in flood hazard areas is relatively static, not rising rapidly, as in England.
• Scotland is taking effective action in a number of areas. The amount spent on flood defences in Scotland has been substantially increased, and by 2001 was running at almost three times the 1999 levels. In Scotland, spending is effectively unlimited, provided the cost of the project is less than the cost of a flood (calculated in insurance claims terms) and provided the project gives the adequate protection. Increasingly the 200 year standard of service seems to be becoming the minimum.
• Scotland has a different system for the cost benefit appraisal of new flood and coastal defence projects. The main criteria are that the design standard is high enough and that benefits exceed costs. Benefits in this case are of course mainly the savings in costs of damage caused by floods. There are three main differences between the different systems: (1) In Scotland, insurance claims data can be used to calculate benefits; (2) The costs of a flood are not calculated on a new for old basis. For example in England and Wales it is assumed that if your five-year old carpet is damaged by flood, you will replace it with another five-year old carpet instead of a new one. Also, in the English system only the direct damage to f.i. a supermarket can be included in the benefits, not the business losses; (3) In Scotland, benefits simply have to exceed the costs of construction of the flood defence scheme, whereas in England and Wales, the benefits of a flood protection scheme must be three to five times greater than the costs.
• One aspect of flood defence spending is that it is very vulnerable to other demands in the public purse. This is perhaps more of a problem in England, where the Treasury has additional calls on its budgets, such as defence, which do not arise in Scotland. Thus, if the Ministry of Defence needed additional funds, the flood defence budget in England might suffer, while the Scottish Executive budget might be less vulnerable.
• Projects in Scotland must also take climate change into account. With precipitation scenarios, Scotland will not be as badly affected in the future by climate change as England.
• Due to natural factors, most of the land in Scotland is rising, while the south east of England is sinking. This means that coastal defences in Scotland are not as badly threatened by sea level rise as in England and Wales.
• Scotland works on flood resilience. There is an insurance representative on the Research Committee of the Scottish Building Standards Advisory Committee, so that vulnerability and insurance issues and expertise are borne in mind when developing new standards (by contrast, there is no consultation with insurers on new building regulations in England and Wales). Insurers are required to use resilient reinstatement techniques for buildings damaged by floods or storms (19). This will cost insurers more in the short term but in the long run, it will reduce claims costs and wastage. For more details about the latest position in England and Wales: www.ukresilience.info/home.htm.

By 2075, according to research for the government, climate change impacts could treble the frequency of  the current design flood. The state of flood defences will therefore become increasingly important to insurers. Even without climate change impacts, the rate of increases in losses is already beginning to be too rapid now for premium increases to keep pace (1).

As the Government’s Stern Review on the Economics of Climate Change concluded: “if we don’t act, the overall costs and risks of climate change will be the equivalent of losing at least 5% of global GDP each year. If a wider range of risks and impacts is taken into account, the estimates of damage rise to 20% or more” (in: 7).

The implications of climate change and the need for a higher standard of protection in the future seems to have been ignored in England and Wales (1). By contrast, in Scotland, flood defence funding will not be granted unless the defence offers at least 100 year protection including climate change impacts to 2060. In effect this is resulting in a minimum standard in today’s terms of around 140 years protection plus an additional freeboard allowance of around 300 mm. Most new defences are being built to much higher standards than this. Almost every Scottish local authority will not allow new developments where the flood hazard exceeds 1 in 200 years.

West and Gawith (20) present an overview of expected climate change impacts on several activities for different regions of the United Kingdom, based on several regional scoping studies. The results for financial and insurance services are listed below. A blank cell indicates that no specific issues were identified for the region besidesthose noted in the first row.Each region identified and discussed issues differently, so this table might not provide comprehensive coverage of all issues.

Region Positive impact on financial and insurance services Negative impact on financial and insurance services Uncertain impact on financial and insurance services Majority of regions New insurance products required Increase in insurance claims from extreme weather. Increased risk of insurance blight   South West Fewer cold weather claims Banks may lose income as customers incur losses. Properties could lose value   South East       London   London will be affected by global markets. Extreme weather may force companies to sell equity, deflating the market   East of England Carbon trading opportunities Property prises decrease in floodplains   East Midlands       Wales   Buildings more at risk from storm damage, flooding and subsidence   North West       Yorkshire & Humber       North East   Increased cost of insurance   Scotland   Greater exposure   Northern Ireland   Increased risk of loss in almost every category of insurance business  

For example, where an incidence of increased tropical storms is expected (as in the southern states of USA and the Caribbean), buildings and transport infrastructure are likely to suffer increased levels of damage - assuming existing construction specifications - leading to increased claims against the insurance industry. Indeed, such claims will impact on the London-based insurance and financial services industries even if the insurer claimed against is not based in London since there might be a (marginal) global squeeze on financial liquidity.

These types of future risk changes are already being considered in the development of the global market strategies within the London insurance industry. The London Climate Change Partnership (21) quoted an insurance sector representative: “insurance has historically been about predicting the unpredictable. Climate change means that predicting the unpredictable itself becomes unpredictable.”

Much of the discussion on climate event risk changes and their repercussions for the insurance sector are relevant to the wider financial service sector in London because of the inter-linking of insurance and capital markets. As an example of the linking mechanisms, the case of lending can be cited. Most private and corporate loans are secured by property. If a region such as London becomes more exposed to climate-related natural disasters such as floods or windstorms, the prices for property could fall - which may result in a loss of confidence in the local economy and may trigger a credit crunch. An indirect consequence of this is that other types of business such as management of private assets and granting of private loans that are not backed by property will also be affected (22).

Climate change could increase insurance costs in high risk areas, which in turn could threaten investments. It could also affect key sectors of the economy which are particularly susceptible – transport, energy, construction and marine industries. Insurance companies recoup the costs or reduce the liability to claims by either 1) increasing the premiums, 2) restricting the cover, 3) applying exclusions or 4) increasing the level of ‘excess’. The UK insurance market is unique in that it does offer cover to subsidence (since 1994). An increase in claims from these natural events could cause the industry to rethink its approach. It could even withdraw from these markets (23).

The ABI states that members will continue to offer insurance up to the 75-year return period hazard. If the hazard is higher than that, no cover may be available (1). Insurance policies last for only a year, a mortgage could last for 25 years or more. If climate change increases the hazard, the insurer can walk away, but the mortgage lender could be left with worthless collateral. There is a very real possibility that most insurers will simply stick with the 100-year return period shown on indicative flood maps. This will leave the majors to pick up the higher hazard cases, thus concentrating such cases in the hands of perhaps five or six insurers, who will be free to charge whatever they want (1).

Britain is suffering from the fact that so much of the thinking about flood defences has been short-term, based on three-year spending plans. What we actually need is sustained and planned investment over a far-longer period, based on full and public assessment of the risks and costs. In particular, we need to take action to improve the quality of our drainage system and our management of surface water (5).

Insurers generally assess flood risk based on geographic location using information provided by the relevant authority. This information is currently limited to flood risk from rivers and the sea but it will be extended to other forms of flooding (e.g. surface water flooding) as this information is developed in line with the EU Directive on Flooding (10).

The response of Governments to flood risk has primarily been to build hard flood defences. However, the hard engineering approach is now losing favour due both to cost and the fact that many of the hard defences currently in place will come to the end of their operating lives within the next 10 years (24), resulting in the increased use of alternative catchment wide management techniques. Another limitation of the hard engineering approach is that although the defences protect from minor flooding events, large events are more devastating if the defence is breeched (25). Particularly for the insurance industry, large catastrophic events are of most concern, as minor flood events cause what insurance companies term “attritional” losses, which can be managed by the imposition of deductibles and sub-limits (13).

Flood defence spending, however, must still account for maintenance and upkeep of existing defences as well as new schemes. As such, Government expenditure on defences has been at the forefront of long term debate. For example, after the summer 2007 floods, the Government increased spending for flood and coastal erosion risk management to a minimum of £650 million in 2008/09, £700 million in 2009/10, and £800 million by 2010/11 under the Comprehensive Spending Review 2007 (26).

In the United States, averaged over the past 55 years, weather-related events have been responsible for 93% of all catastrophe events, 83% of the economic damages of natural disasters, and 87% of the insured losses. ... The observed upward trend in losses is consistent with what would be expected under climate change and with demographic factors (37).

1. Traditional (private) insurance systems. This system is in place in most European countries (in 15 out of 19 studied countries). Systems are set up and managed by private companies, where the cover is financed from premiums that are paid before the event (ex ante). Some of these systems may have support from the government, for instance through state-guaranteed reinsurance. Countries where at least half the population has taken out flood insurance are: Portugal, Spain, France, the United Kingdom, Hungary, Norway and Sweden. Countries where less than half of the population has taken out flood insurance are: Italy, Greece, Austria, Slovakia, the Czech Republic Germany, Poland, Finland;
2. Insurance or pooling systems in which the government has a considerable role, through setting up and managing the pool. Cover is provided through ex ante premiums or ex ante taxes on insurance policies. This is the case in Belgium, Denmark and Switzerland. In Belgium, however, a compulsory insurance system has been put in place since late 2005;
3. Systems administered by the government, consisting of ex post compensation of flood losses. These systems are not considered to be insurance, as the basic property of ex ante premium or tax collection is not present. Rather, loss compensation is paid from tax money, either ad hoc or through budget reservations. Out of 19 studied European countries this system is only in place in the Netherlands.

Insurance markets are rather imperfect and are unlikely to generate adequate adaptation responses to climate risk due to uncertainty and imperfect information, missing and misaligned markets and financial constraints. Government support is therefore necessary and widespread in the EU and elsewhere. Governments of EU member states regulate, subsidize or even offer insurance for flood or drought risks; yet, in many instances markets and public-private partnership offer only limited coverage or are extremely restricted, such as for flood risk in the Netherlands, which leads to substantial government liabilities for member states, which to some extent are buffered by the EU solidarity fund government compensation scheme (43).

The table below summarizes the key properties of insurance and compensation systems for covering losses incurred by households and business in a selection of EU member states (44). Private insurance systems (“bundle system” or the “option system”) are distinguished from government solutions (ex post compensation by the government, paid from tax revenues). The fifth column indicates whether private insurance is compulsory. Finally, the level of market penetration of the insurance system has been estimated.

Member state Insurance/compensation system Insurance compulsory Market penetration   Private, ex ante, premium bundled Private, ex ante, premium optional Government, ex post compensation     Austria   X     10-25% Belgium X     X >75% Czech Republic   X     25-75% Finland   X X   10-25% France X     X >75% Germany   X X   10-25% Greece X   X   <10% Hungary X   X   40-60% Italy   X     <10% Netherlands   X X   <5% Poland   X X   25-75% Portugal X       25-75% Spain X   X X 25-75% Sweden X   X   >75% UK X       >75%

EU Solidarity Fund (EUSF)

Recognising that floods and other disasters may lead to overburdening national governments and necessitate international assistance even in Europe, the EU Solidarity Fund (EUSF) was created after the floods in central Europe in summer 2002 and entered into force on November 15th of that year (45,49). Member states, and countries applying for accession, can request aid in the event of a major natural or technological disaster (46). The fund provides financial aid for emergency measures in the event of a natural disaster causing direct damages above 3 billion Euros (at 2002 prices) or 0.6% of the GNI (47). Fund support can be mobilized even if the threshold is not met, e.g. for a neighbouring country that is affected by the same major natural disaster or for extraordinary regional disasters which affect the majority of the population of a region and have serious effects on its economic stability and living conditions. There is no equivalent to addressing drought and water scarcity, however (43).

The current EU extreme event interventions are not sufficient to cope with future extreme events projected to increase in size and intensity as a result of climate change (43.

Technical Risks

• Shortening times between loss events, such as more hurricanes per season,
• Changing absolute and relative variability of losses,
• Changing structure of types of events,
• Shifting spatial distribution of events,
• Damages that increase exponentially or nonlinearly with weather intensity,
• Widespread geographical simultaneity of losses (e.g. from tidal surges arising from a broad die-off of protective coral reefs or disease outbreaks on multiple continents),
• Increased difficulty in anticipating "hot spots" (geographic and demographic) for particular hazards,
• More single events with multiple, correlated consequences. This was well evidenced in the pan-European heat catastrophe of 2003. Immediate or delayed impacts included extensive human morbidity and mortality, wildfire, massive crop losses, and the curtailment of electric power plants due to the temperature or lack of cooling water, and
• More hybrid events with multiple consequences (e.g. El Nino-related rain, ice storms, floods, mudslides, droughts, and wildfires).

Market-based Risks

• Historically-based premiums that lag behind actual losses,
• Failing to foresee and keep up with changing customer needs arising from the consequences of climate change,
• Unanticipated changes in patterns of claims, and associated difficulty in adjusting pricing and reserve practices to maintain profitability,
• Responses of insurance regulators,
• Reputation risks falling on insurers who do not, in the eyes of consumers, do enough to prevent losses arising from climate change, and
• Stresses unrelated to weather but conspiring with climate change impacts to amplify the net adverse impact. These include draw-downs of capital and surplus due to earthquakes or terrorist attacks and increased competition from self-insurance or other competing methods of risk-spreading.

Pressure on insurance affordability & availability under climate change

Extreme weather events have already precipitated contraction of insurance coverage in some markets, and the process can be expected to continue if the losses from such events increase in the future. Impacts vary, of course, depending on the specific circumstances, and can be relatively minor (gradual price increases) to more significant. For the United States, the following outlook has been presented for different types of issues (37):

• Flood - currently a mix of public/private insurance and risk sharing. Under climate change, insurability problems may extend from the present personal and small commercial lines into larger commercial lines.
• Windstorm—a largely insured risk at present. There are already considerable insurability problems and associated changes in terms and pricing, non-renewals, market withdrawl, etc. This could increase dramatically under climate change, resulting in shifting of losses to governments and consumers.
• Agriculture and livestock—currently a public/private insurance partnership. Climate change will stress this sector considerably, with potential for impacts due to drought, flood, pests, or other events on a scale with the Great Dust Bowl of the 1930s.
• Wildfire—currently largely privately insured. More retention of risk by purchasers of insurance and more involvement by state governments is anticipated, while insurers raise deductibles and reduce limits of liability and scope of coverage.
• Mold and moisture damage—largely commercially insured until the crisis emerged a few years ago. Now, many states have exclusions.
• Earth movement and coastal erosion—primarily insured by government, if at all. With permafrost melt, subsidence of dry soils, sinkholes will become more prevalent, as will mudslides and property losses from coastal erosion. Government programs covering storm-surge-driven losses on eroded property could be overwhelmed with losses under climate change, with the result of more retention by property owners.
• Health impacts—currently largely privately insured. An insurability crisis under climate change is not anticipated. Impacts will manifest in the form of elevated health insurance prices.

Clearly, where the costs adaptation are low but the benefits of lower expected losses are greatest then investing in adaptation will be most economic. Where adaptation costs are significant, the economic solution may be to make greater use of insurance based instruments to pool the costs of the risks.

Virtual water trade

The UK may wish to protect the supply of certain commodities from specific countries, or at certain cost levels, in which case the climate adaptation strategy would need to adopt an international dimension that encourages water management measures in the countries exporting these commodities to the UK. Alternatively, the UK could begin to consider developing new trade relationships with countries that are likely to be less negatively impacted by climate change and that would therefore provide either a lower-cost or more reliable supply of commodities (50).

Insurance

The Association of British Insurers (10) advices to ensure that the relevant authority on flood risk is consulted on, and approves, proposals for all new developments where there is a risk of flooding from any source. This is the Environment Agency in England and Wales, the Scottish Environment Protection Agency or the Northern Ireland Rivers Agency. Insurers expect to be able to insure developments that are built in line with advice from these responsible authorities. Where developments are not approved, insurance is likely to be more difficult to obtain.

There are divergent views on how the banking sector will be impacted by climate change. One view is that the nature of the industry - large, diversified banking institutions - means that any loan exposure will be minimal since no substantial portion of the loan will be kept for any long period. Risk management of potential climate change impacts, coupled with the implementation of regulatory regimes for greenhouse gas emission mitigation, provide significant business opportunities. Risk management is resulting in the development of markets for e.g. catastrophe bonds and weather - related trading in the international financial markets. Similarly, the reality of a carbon-constrained future for all business is already manifesting itself in the application of energy-focussed audit work for consultancies as energy use becomes a part of companies’ business strategy. Finally, there is a developing market in carbon trading which London is in a very good position to exploit as an established trading centre (21).

Sustainability has been brought to the forefront of governmental plans as understanding of flooding and its impact has increased, with a more holistic approach to water management, explicitly expressed in the governmental guidance ‘Making Space for Water’ (28).

Although local planning authorities have remained the principal guardians of development approval, the political and social demands made of them by communities and planners alike in the pre-2006 period resulted in the approval of many developments on at-risk sites (29). A fundamental readjustment of planning procedures has been established under recent changes in planning policy, which made the Environment Agency a statutory consultee in October 2006 (30). Planning Policy Statement 25 (PPS25) on Development and Flood Risk (31) is the main document for planning for flood risk and is a fundamental instrument for directing development to areas of lower flood risk where possible.

A further recommendation is that local authorities become the main overseer of surface water flooding, as they are already in charge of local planning and development and it is logical to add this responsibility to their remit. This refinement of policy and guidance in addressing all sources of flooding represents an improvement on the complicated, fragmented approach of the pre-2006 period and also complies with EU requirements for an integrated approach to policy provision in flood catchments (13).

When siting developments the impact of the defences must also be taken into account. The construction of hard defences may lead to the ‘escalator effect’ (32), where defences protecting an area create a ‘safe’ environment, encouraging development and thus resulting in ongoing construction to maintain the defences in place, creating a perpetual cycle of  unsustainability. The use of hard defences alone is now seen to be an insufficient response to flood risk, both from an economic viewpoint and on the sustainability front, as compared to other flood management alternatives (33).

It is encouraging to see that flood resilience is playing a greater role in the design of new buildings within the Thames Gateway, for example at the Mast Quay development in Woolwich, where residential units are above ground floor level. When change does occur it can be expected that it will be driven by the insurance industry rather than by the Government. If insurers find the risk to be too great to provide cover for flooding, the onus is on the Government to reform policy to prevent the housing market and mortgage provision from being adversely affected (particularly important in the current market climate). The levels of risk therefore still remain to be seen, but it can be expected that policy in relation to flood risk remains open to change and pressure from insurers (13).