Role of Insurance in Reducing Flood Risk

Over 90 per cent of all deaths from natural disasters are water related, and 99 per cent of deaths from flood from 1975 to 2001 (over 250,000 people) were from low-income groups. In richer countries, total disaster losses are generally less than 2 per cent of GDP, while in poorer countries the figure is nearly 14 per cent.

Architects have an important role to play in helping society to become more resilient but so do insurance companies. Some of the leading insurance companies have considered climate change adaptation very seriously, especially following Hurricane Katrina.

Summers will generally be drier with drought and subsidence problems, but there will still be extreme rainfall leading to flooding as was demonstrated in England in the summer of 2007. Winters will be wetter, again leading to more flooding.

There is a growing realisation that civil engineering solutions are not enough. For flood management to be sustainable other, more natural flood management is needed. The insurance industry will have an increasingly important role in helping society to adapt and become more resilient.

Some ways in which insurers can help are:

Assistance with identifying areas at risk.
Catastrophe modelling.
Economic incentives to discourage construction in the flood plain.
Collection of data on the costs of flood damage to feed into benefit cost appraisals for flood management schemes.
Promotion of resilient reinstatement techniques.
Promotion of temporary defence solutions.

The extent to which insurers can help society depends very much on how flood insurance cover is arranged and this varies depending on the country.

It also depends on how sophisticated the country’s insurers are in mapping flood risks and how much the insurers are regulated by government. The more the regulation, the less the insurers can use market forces to manage the risk.

How insurance operates around the world for residential properties

There are many different approaches to insurance in different countries around the world. Where private flood insurance cover is available (and it is not available in all countries, for example Holland) such different approaches can be categorised into just two basic types, what Crichton calls the ‘‘option’’ system and the ‘‘bundle’’ system.

The option system

Under this system, insurers agree to extend their policy to include flood on payment of an additional premium. This system can be found in Belgium, Germany and Italy for example, and in the North West Territories of Australia, but the take up rate is very low.

There are a number of problems with optional cover. Apart from the problems of defining what ‘‘a flood’’ means so it can be excluded, the biggest problem is adverse selection.

Adverse selection means that insurers tend to select against customers by only making the cover available in areas they consider to be safe, while customers select against insurers by only buying it in areas they deem to be risky.

The result is that cover, when it is available at all, is expensive, and has very low market penetration. Such insurance is unlikely to be sustainable because a big enough ‘‘book’’ of business cannot be achieved.

In countries where the government will step in to compensate flood victims, this further reduces the effective demand for insurance.

The bundle system

In this system, cover for flood is only available if it is ‘‘bundled’’ with other perils, such as fire, storm, theft, earthquake, etc. This system is used in Britain, Japan, Israel, Portugal, and Spain, for example.

With the bundle system, insurers have the freedom to charge differential rates, but excessive rate increases can be mitigated because the risk is not only spread over time, but across perils, and across rating areas.

People living in areas safe from flood still have to buy flood cover if they want to get earthquake cover, for example (as in Portugal), and vice versa. This system is characterised by much higher market penetration. Because everyone is paying for flood insurance whether they think they need it or not, this reduces the opportunities for adverse selection by customers.

The effects of the variability and increasing uncertainty of climate change on flood risks

Within Europe, more than 10 million people live in areas at risk of extreme floods along the Rhine, and the potential damage from floods amounts to h165bn. Coastal areas are also at risk of flooding.

The total value of economic assets located within 500 metres of the European coastline, including beaches, agricultural land and industrial facilities, is estimated at h500 to h1,000bn.

In Britain, reports from the ‘‘Foresight’’ programme of the Office of Science and Technology show that the flood hazard in Britain will increase significantly in the next 100 years with the number of people at risk increasing from 1.6 million to between 2.3 and 3.6 million by 2080.

Drains and sewers in towns and cities could be particularly affected by climate change and increased flooding. Short duration rainfall events will become more severe, resulting in more flooding from drains and sewers.

New European standards for urban drainage (EN 752) are based on flood frequency rather than rainfall return periods as in the past, and therefore drainage designs will in future have to take into account other factors such as pre-existing groundwater levels, or changes in urban runoff.

Even so, the new standards only require drainage to cope with a 1-in-30-year event in urban areas, which is hardly adequate in the context of climate change.

Lindholm13 describes recent court cases in Norway, which have challenged this limit and allowed insurers to recover flood claim costs for drainage failure caused by events up to 1 in 100 years. All mainstream scientists now agree that climate change is happening and the impacts will get worse.

The latest projections of extreme events in Europe are detailed in a report14 from an EU project called ‘‘the Prediction of Regional scenarios and Uncertainties for Defining EuropeaN Climate change risks and Effects’’ (PRUDENCE).

The main conclusions are that by 2071–2100:

Heatwaves will have increased in frequency, intensity and duration especially over the continental interior of Europe.
Precipitation will show major changes. There will be heavier winter precipitation in central and northern Europe and decreases in the south. Heavy summer precipitation increases in NEEurope and decreases in the south are projected. The summer floods in England in 2007 are consistent with this (see below). Longer droughts will happen in Mediterranean countries, but there could still be severe rainstorms with faster runoff.
Extreme wind speeds will increase between 451N and 551N except over and south of the Alps, and become more northwesterly. These changes are associated with reductions in mean sea level pressure and will generate more North Sea storms, leading to increases in storm surges along the North Sea coast, especially in Holland, Germany and Denmark.

Dronia has suggested that winter storm tracks may move south: this would affect areas such as France where buildings may be less resilient than in Scotland or Scandinavia, as happened in 1999.

Indeed, Alain Joly, director of research at the French national meteorological research centre has warned of a 50 per cent increase in the number and severity of storms in France by 2080. Sea levels are rising as sea water expands due to rises in temperature and as polar ice melts.

With a rising sea level, tsunami events and storm surges will become more damaging. With a warming ocean, tropical storms are likely to increase in frequency and intensity. Such storms can frequently cross the Atlantic and end up in Europe.

Shallow slope coastal areas are particularly vulnerable as storm surges are higher there and run up further.

Hurricane Anatole in December 1999 created an unprecedented 5- metre storm surge on the west coast of Denmark, which resulted in coastal defences being overtopped or breached and thousands of properties damaged.

Low lying coastal areas in the Gulf of Mexico suffered from storm surges in excess of 8 metres in 2005. Society will need to adapt urgently, but in England there seems to be more ‘‘maladaptation’’.

Location: Indonesia