Appendix 8: Private Flood Insurance Solutions around the World
From studying two comparisons of a sample of countries around the world it seems clear to this writer, that there are really only two types of private flood insurance for residential properties, 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, 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. 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. From the point of view of the BASIC MUD rules (see Appendix 7), it is unlikely to be sustainable, because of adverse selection and 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 storm, theft, earthquake, etc. This system is used in Britain , 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, and vice versa.

This system is characterised by much higher market penetration, around 95% in Britain and Israel . This is probably a reflection of the extent of property ownership by individuals and the requirements of mortgage lenders, rather than any particular desire to have comprehensive cover.

Because everyone is paying for flood insurance whether they think they need it or not, this reduces the opportunities for adverse selection by customers. From insurers' experience in Britain, it can be argued that everyone needs flood cover even if they are not near the coast or a river, simply because of surface water run off where the drains are too antiquated to cope with the volumes of water from a heavy rainstorm.

It has been argued that insurers need not fear adverse selection with regard to flood hazards, because these are widely known. After all, in most countries, flood maps are in the public domain and readily available to insurers and the public alike. However, as has been shown earlier in this report, lack of government investment in flood mapping, means that flood maps of England and Wales only appeared in the public domain in 1998 (2000 for Scotland), and are very limited in scope.

Concerns about possible adverse selection have caused a number of major insurers in the UK to each invest substantial sums in better flood maps for their own use. These maps are better than the UK government or its agencies have been able to afford so far. Such research has been expensive, and the insurers who have paid for it jealously guard the information. It may come as some surprise to those outside the UK that so many private insurers have made this investment. The investment has been justified because of a lack of good quality public domain data and because of the high penetration of cover, which has enabled the costs to be spread over a large number of policies. The bundle system means that every policy has the potential to produce flood claims, and insurers have to know what their total exposure is likely to be.

The adverse selection argument is nevertheless valid in the case of people who have actually been flooded, and therefore know they are at risk. Indeed in 2001, some UK insurers started to apply large flood excesses, up to £5,000, and heavy premium loadings for properties where flood claims have been made.

Insurers' main cause to fear adverse selection is where, in effect, one insurer is selecting against another. This is happening in connection with block business schemes arranged by mortgage lenders. In such cases, adverse selection is becoming a real problem even for bundled policies.

In the UK there is a practice amongst finance houses that lend money to those wishing to buy a house, to insist that the house be comprehensively insured in order to protect their collateral. These finance houses will usually arrange block policies with a preferred insurer who then has to accept any property his principal decides to lend money on. Recent consumer pressure has forced mortgage lenders to allow customers to opt out of the block policy and arrange their own insurance. Some insurers are actively "cherrypicking" from this client base by encouraging selected borrowers to move their insurance to them. They only offer this encouragement of course, where the borrowers live in a safe area, and ultimately there could be a vicious circle situation for the finance house.

Analysing the same sources as in the previous section the writer has concluded that, apart from the USA , which has a rather different system, there are three categories of state involvement in compensation for flood victims, and these are outlined below. First, however a general point needs to be made; there seem to be very few examples of a country deciding to arrange for reinsurance cover from foreign reinsurers, all the costs are kept within the boundaries of the country. This could be dangerous if there is a major catastrophe or series of catastrophes because the country may find itself in financial difficulties or at the very least find it difficult to attract capital investment in the future.

Reinsurance offers a very cost-effective way to spread the risks across the economies of other countries so that if one country is hit by disaster, other countries automatically step in with support.

No state compensation for citizens (although there may be grants for infrastructure). Argentina , Germany , Israel , Japan , Portugal , UK

This causes severe problems for those where private insurance is not available or is not affordable. Such people are often the hardest hit when a flood strikes, and the resulting stress and other health consequences could be serious. Even if insurance is available, the mental trauma of losing items of sentimental value can have a direct economic impact which has never been properly measured, and which can recur whenever there is the threat of another flood. Often the only long-term solution is relocation to a safer area.

The author is not aware of any research into the psychological damage caused by floods, but it is clear that there is a need for trained counsellors to be on hand to help people to talk through their problems and despair. In the UK , this service is provided by a voluntary org ani sation called "The Samaritans", part of Befrienders International, and the value of their services is often underestimated. Women in Muslim communities can be particularly hard hit, as they are left in the desolated home while the men go out to work.

As stated before, flood insurance penetration in the UK overall runs at around 95%, but this figure is misleading. In the case of people in lower socio economic groups, the penetration drops to around 30%. These are precisely the groups most likely to be flooded, because they live in housing built on cheap land, which is often floodplain. However, flooding is now becoming so widespread and frequent, and building land in such short supply, that wealthier people are beginning to suffer, and rightly or wrongly, they have a much more powerful voice. In the UK floods of 2000, a number of television celebrities and senior legal figures saw their homes being inundated, and this raised the profile of the subject in the media. (It also resulted in the legal profession looking around for someone to sue, with some success.)

A government commitment not to compensate the victims of a flood or other natural disaster raises many important economic and moral questions, perhaps worthy of exploration elsewhere. From an insurance point of view it has certainly done no harm to the demand for insurance, and in turn the presence of a strong insurance industry has helped to mitigate public protest at the lack of government compensation.

Procedures to provide compensation in hardship cases. Australia , Canada , and China

This is a pragmatic solution, but not necessarily the best. The State may not be well geared up to assess how much compensation to pay or to administer it efficiently, whereas insurers have the systems in place to pay out fair levels of compensation. Also some citizens might regard such compensation as 'charity' and be too proud to accept it.

Compensation only by decree after the event. Belgium , France , Italy , Spain , USA .

This can be dependent on the whim of a politician who could be influenced by many other issues, not all entirely objective. The main effect is that while such a scheme can be very expensive for the State, the citizen is never sure in advance if he will be protected, and may be reluctant to invest in his property if he thinks it may be flooded.

In the USA , for example, government disaster aid has only been given for 50 percent of recent flood events. (There is some indirect government compensation for businesses in the USA in that flood losses are tax deductible.)

The USA System

The system in the USA is unique and has not been copied by other countries. A National Flood Insurance Program (NFIP) was set up in 1968, and is the only Federal insurance scheme for natural disasters in the USA . NFIP just provides basic cover, and additional cover is available from private insurers. It only applies to eligible communities where the flood risk has been assessed and a program for loss mitigation has been established. Such loss mitigation programs generally involve expensive structural defences, and recent research has suggested that some of these can actually increase the risk of flooding.

Premium levels are high, and before the 1993 Mississippi floods, penetration in flood hazard areas was only 15-20%. This increased by about 50% after the floods. Cover cannot be refused, so adverse selection is a big problem. Properties with recurring flood losses represent only 2% of the NFIP policies, but accounted for 40% of the losses between 1978 and 1995. Poor risks are subsidised by the Federal Emergency Management Agency (FEMA) and the NFIP is currently heavily in debt to FEMA. No reinsurance is purchased on the international markets to spread the costs outside the USA economy (Swiss Re, 1998).

The NFIP uses private insurers to settle claims on their behalf because of their claims handling expertise, but there is anecdotal evidence that because the private insurers recover their costs from the NFIP, the claims costs are higher than they would be under a private insurance scheme.

To sum up, the USA system is subject to considerable adverse selection, it encourages people to live in flood hazard areas, and it undermines the private insurance market, which does not have the benefit of being subsidised by the taxpayer.

On the other hand, the potential flood losses in the USA are now so severe due to the numbers living in the danger zone and the growing hazards from climate change that it is doubtful if any private insurer would be prepared to consider the risk.

The USA does not seem to satisfy the BASIC MUD guidelines, since the exposure is so high and take up for public insurance is so low, despite multi million dollar subsidies from the Federal Government.

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