The Basic Concept and Need of Flood Re - Essay Example

?INTRODUCTION Floods over the years have resulted in high death tolls in different parts of the world. There have been a number of disasters and deadly floods in the world that have resulted in the death of more than millions people. For instance, Indian Ocean tsunami is one of the recent and renowned floods that resulted in death of more than 280,000 people in Indonesia1. Tsunami not only resulted in the death of so many people, but the areas that were affected and the economy of Indonesia was hurt immensely. Indonesian economy is mainly dependent on two main sectors; fishing and tourism. These sectors were badly affected2. The fishing industry offers employment to around 250,000 people in Indonesia and thus, with this tsunami there were a number of people that lost their jobs3. Tsunami not only has resulted in the death of local people in Indonesia, but there were a number of tourists from different parts of the world especially from Europe that came under the fire as well. Around 9,000 foreign tourists were dead in this flood, and most of these tourists were from European countries4. However, there is little that the government can do in such a catastrophic situation. Although there are certain techniques and strategies that the government can take in order to reduce the impact of these floods such as Stormguard Flood-plan can be implemented in order to be better prepared for such situations as well as to reduce the impact of such disasters5. Similarly, there have been floods in United Kingdom as well. Although the disasters were not as high as Indian Ocean tsunami but still a large number of people lost their lives. North Sea flood is the worst flood that has occurred in United Kingdom6. North Sea flood occurred on 31st January, 1953 and a number of areas were affected including Belgium, Scotland, Netherlands and England7. The causalities because of the North Sea flood were equaled to 2,142 including 354 people that lost their lives in United Kingdom alone8. Another important flood in the history of UK came in the year 1607. This flood was more devastating in nature as it resulted in the death of more than 3,000 people. Not only this flood affected the lives of people, but the economic situation of the country was badly affected9. This flood swept away a number of houses and villages along with ruining different farms. Thus, it badly affected the economic situation of the country. The damage estimated was around ?5,000 which if compared in today’s monetary terms would be equal to ?740,00010. The London School Of Economics has announced and warned about flood risk in Britain. According to the research conducted by the school Britain is a highly risky area because of the changes in climate along with the continuous development in floodplains for both residential as well as commercial properties. Centre for Climate Change Economics and Policy and the Grantham Research Institute on Climate Change and the Environment have conducted research and published the paper. They have also been consulted by the British Department for Environment, Food and Rural Affairs (DEFRA)11. Therefore, this paper has raised concerns and risks for people that are buying and investing properties. In order to overcome this issue and concerns of the public, the Association of British Insurers (ABI) along with the national government has come up with the Memorandum Of Understanding (MoU) which is known as Flood Re. This Memorandum Of Understanding (MoU) has been signed between the government, and the carriers and on the basis of this MoU, a non-profit or a not-for-profit flood fund has been developed12. Association Of British Insurers (ABI) is an important company in the insurance industry as it has more than 90% of the market share in the United Kingdom insurance market13. The basic idea of this Flood Re is to offer a cap flood insurance premium for the property owners. This insurance premium will be according to the value of the properties. Moreover, this fund will offer insurance to people that are at a higher risk for flood as well as to those people that may find it difficult to get reasonably priced flood insurance14. This essay is aimed to critically analyze the newly proposed Memorandum of Understanding introduced by the UK government, which is also known as Flood Re. This essay shall introduce the basic concept of Flood Re and how would it work. The second section of this essay shall examine the advantages and disadvantages of Flood Re to the public. In addition to this, this essay suggests possible recommendations to the new system and how this MoU could have been improved. THE BASIC CONCEPT AND NEED OF FLOOD RE The main concept and idea of Flood Re is to offer affordable and reasonable priced insurance to people. According to the press release published, Memorandum of Understanding (MoU) is only one of the first steps to the public regarding the flood and its risks15. Insurance industry of United Kingdom is a multi-billion pound industry, and it is also one of the leading insurance industries in the world. There have been a series of agreements that have taken place between the government and the players in the insurance industry of UK since 1960s16. It is essential to notice that nearly 20% of the total properties which equals to 5.8 million properties are subject to flood risk17. With the introduction of this MoU, UK citizens will be able to insure their properties from flood by paying approximately ?10.5 annually18. Association of British Insurers (ABI) believes that it has become necessary for the government to come up with some strategies and approach in order to safeguard and provide affordable insurance from flood to the people residing in United Kingdom. Moreover, Association of British Insurers (ABI) has stated that the flood insurance statement of principles which was introduced in the year 2000 was not up to the mark. Moreover, ABI has stated that the statement was only a temporary solution for the people of United Kingdom. In addition to this, the statement implemented in 2000 had some restrictions from the perspective of consumers such as the insurers could only have commitments with their current consumers. Moreover, the new insurers will have the option to select the person to offer flood insurance to whosoever they want to. In addition to this, the other reason for eliminating the statement and coming up with Flood Re is that the statement was not offering guaranteed and affordable premiums for flood risks despite the fact that more and more people have started to struggle to pay for the flood insurance19. With the introduction of Flood Re, people would be able to insure their property at risk of flood by paying limited amount of premium. Therefore, it will reduce the vulnerability of the un-affording segment of the inability to insure their property due to high premiums. It is important to highlight that the insurance industry in UK has undergone tremendous changes in the recent past. If the industry continues in the same trend, the consequences of the changes in the insurance industry of UK would be immensely challenging for the property holders to secure and sell their property. In addition to this basic objective of this MoU, Flood Re has encompassed various other perspectives and minimizing the losses is one of the main objectives20. The losses incurred from the flood that took place in July 2007 caused financial losses of nearly ?3.2 billion, where according to BBC news “Thirteen people died and hundreds had to be rescued after parts of South and East Yorks and Gloucestershire flooded. Moreover, Around 48,000 homes were affected, each costing between ?20,000 and ?30,000 to repair.”21 Additionally, ABI reviewed and stated that economic damage cost by floods has steeped by nearly 200% as compared to the year 199022. With this accelerated rise in cost, the climate change has increased risk of flood to nearly one million people in the next 15 years. Clemo has stated in his research that there are high risks of flood for people in UK particularly because of climatic changes and global warming.23 This has not only pushed up the need of the programs to safeguards people from such risks but it also aims to minimize the economic losses. These challenging costs and risks also make it mandatory for the government to make effective monetary arrangements than marking cuts in the budgets. Furthermore, there is a need to integrate comprehensiveness in the program of Flood Re, so it is able to accommodate the impact of worsening impact of climate. It is also important for the government to ensure that the program is able to offer affordable and fairness solution to a wider set of people at may be affected from flood risk. The UK Government is also required to ensure that the program is lasting and does not require roll out as happened to the Statement of Principles that was terminated on 30th of June 2013. The idea is based on the mutual consent from the insurance industry that aims to provide affordable insurance facilities to an increased number of people. Similarly, it is the intention of the government to provide cover to its people against the rising threat of flood. Hence, the proposal is the response to the mutual need and shared vision of the government towards the benefit of the people. KEY ELEMENTS OF THE FRAMEWORK The central idea behind the MoU, as stated in the above section is to provide affordable insurance to the people at risk of flood. This was in the collective interest of the insurance industry, people and the government and is defined as the shared vision for the benefit of people of UK. For achieving this shared vision, MoU is developed and it has following key elements24: The Program of Flood Re will be a fund to cover the claims of flood from the areas of high risk. It will be a non-profit venture which will be funded and governed by the insurers. According to the publication on November 2013 from the Department for Environment, food and Rural Affairs, households in UK will be required to contribute in creating this fund which will then be used to pay the claims from homes in areas with high flood risk25 The risk of flood will be spread to the funds from the households in such high risk areas. This will lead to the capped premium to be charged to the insurance buyers. The limited premium will be determined on the basis of the tax band determined in council tax band. The council tax band is used to determine the eligibility for the capped premium in the given plan. MoU has clearly outlined the eligibility threshold for the insurance premium which is also linked to the Consumer Price Index (CPI). The caps determined for the price of risk paid by the consumer are presented in the table below Council Tax Band A ?210 p.a. Council Tax Band B ?210 p.a. Council Tax Band C ?246 p.a. Council Tax Band D ?276 p.a. Council Tax Band E ?4330 p.a. Council Tax Band F ?408 p.a. Council Tax Band G ?450 p.a. Properties build after January 2009, and those that are considered uninsurable with some genuine reason will be excluded from the benefit offered under Flood Re. For the policies abandoned from the Flood Re will be entitled for the standards excess. The range defined for the purpose is ?250 to ?50026. Each of the member insurance firms will be required to contribute around ?180 million on an annual basis. This will form the subsidy of nearly ?10.50 on the levy on premiums that is to be charged on the premiums of insurance on household. This amount also represents the level of subsidy that exists between extremes of flood premiums being charged. According to the proposal27, if the funds generated for the Flood Re has any shortfall, the members will be required to fund additional amount in accordance with the system agreed among insurance members. Importantly according to the Department for Environment, Food and Rural Affairs, MoU has outlined that support to the insurer would be for a limited time. It will also be transitional as it will allow the adjustments. With this at work, the insurance market participants would then be able to make necessary adjustment with respect to the risk. This flexibility will allow the MoU to adjust prices as required in line with the objective of supporting the flood risk victims28. The plan of Flood Re is designed to cover minimum of 99.5% of years. Furthermore, the plan is also aimed to consider and cover the worst situations as left in the remaining 0.5% of years. This 0.5% accounts to the worst situation which can arise once in 200 years or the floods with devastating impact of nearly six times to that happened in the year 2007. The MoU is still under the process of development and assessment of its viability. With all these issues resolved, the arrangement is expected to be operational by 2015 summer. From the date of affect, Flood Re Proposal: MoU will be a transitional program which will gradually be phased out within 20-25 years. Furthermore, as the levy will remain the same for the five years of affect and on the completion of the five years period, it will renegotiate price to be charged and subsidized accounting different factors29. The Flood Re Proposal: MoU chalks out with this program at work, insurers of the domestic flood risk policies will be provided with an opportunity to put their policies in the Flood Re program. Insurers with consideration that their respective policy is charging a higher premium as compared to the one defined as the eligibility threshold can take benefit. However, it will be at mere discretion of Flood Re to determine the framework for the reinsurance of such domestic policies. In addition to the above mentioned elements that determine the system of work for the Flood Re program and the insurance industry, it is also important to notice that the primary responsibility remains with the government. The key elements from the government perspective are as follows: Amendments in the Water Bill to result in the fund generation of Flood Re program by policy buyer holder and managers of the program. This is a positive move in order to overcome the challenge of free-riders that often arise in government backed programs for people’s support. The government will also issue formal acceptance of responsibility sharing for the program in terms of commitment towards expenditure. The government will provide the complete and relevant database for the implementation of the program effectively and efficiently. Mutual understanding and free of charge sharing of information from both parties. For instance, Flood Re management will provide the government with the claims schedules while the government will facilitate the program managers with environmental information in anticipation of the floods. The mutually agreed and worked out system is formed to ensure prudential regulation and approval requirement from the different agencies such as the ABI, the Developed Administration and the European Commission and other agencies involved. ADVANTAGES OF THE FLOOD RE The first advantage of the Flood Re is the fact that Flood Re shall benefit people at high flood risk zone with affordable insurance policies. The property holders in the high risk zone often end up paying the high cost for the insurance cover only because they are situated in areas that have high risk. This has opened ways for broadening the base of customers to the insurance industry while adding opportunity for the property holders in such areas with insurance cover. Cullen (2013) has reported different benefits that current Flood Re program will be offering to the insurance providers and takes30. First, the program will not require any significant change in the process for availing the insurance. This will play a positive role in the implementation of the program and adoption by the insurance policy holders31. Implementation of the systems is significantly affected by the typical procedures, which in turn has negative impacts on the derivation of effective benefit from the plan. Secondly, the houses in the high-risk areas that were initially not considered as market by the insurer are now open for expansion for the insurance providers32. Hence, the program will serve as the barrier remover for the expansion of the market. Thirdly, the benefit of cross subsidy will be gained, and in addition to the normal premium collected for meeting the claims, the insurance industry will further spread the cost to other insurance holders. Fourthly, Flood Re shall be accessible by the people who really deserve it. This can managed by connecting this benefit to the council tax band, while at the same time controlling the free-riding by many in the economy. Hence, the above mentioned four aspects of the Flood Re are immensely valuable. The insurance industries increased exposure to the high risk market is immensely valuable. Exposure to new sections of the industries is costly in the initial phase. However, as the exposure expands in terms of time and scale, the industries are then able to explore ways to exploit further opportunities. These opportunities can be in the form of economies of scale, learning and experience curve and so on. The insurance industry with this new avenue is then expected to develop further products while generating benefit in terms of cost efficiencies. Moreover, the market for insurance will also increase as construction in such high risk areas will expand owing to the availability of insurance. As the cost of the flood is immensely high and pressures the public budget, therefore, such insurance program will play the role of the cover to the government as well. It is an ultimate matter of fact that the government has to bear the cost of the flood devastations mainly of the high risk areas which are most likely to be not covered under any property insurance policy. This program, on the other hand, provides calculated measure and coverage from the worst flood impacts. Therefore, unforeseen costs to the public shall be reduced significantly. According to the estimates generated by the government, nearly 500,000 houses in UK will be able to benefit from this program if implemented. According to a study that examined the flood impact and cost in Netherland, concluded that success of the systems shall be gauged in terms of various perspectives than monetary costs only33. The consideration to the welfare, environment and ecology benefits are identified as important dimensions in calculating the cost of the strategy. With this yardstick of success of the system in place, the benefit of the referred Flood Re program is confined to net of 300,000 houses in UK from the total 500, 000 claimed from the government. This is due to the fact that nearly 200, 000 houses would be required to pay an additional premium due to this program34. However, as the program is centrally aimed at providing affordable insurance cover to a wider number of people, therefore, the program only has economic benefits. Hence, both direct parties of the MoU, the government and insurance industry, have established the consensus while compromising their certain benefits for the overall welfare of the people with property at high risk of flood. However, the compromise for the overall benefit of the people is only achievable if the project is implemented with full efficacy. DISADVANTAGES OF THE FLOOD RE It is an undeniable fact that each program or agreement has certain limitations associated with it. Similarly, Flood Re’s proposed MoU has certain disadvantages or limitations, which shall be examined in this particular section. British Department for Environment, Food and Rural Affairs (DEFRA) noted the disadvantages of Flood Re. DEFRA has concluded that the MoU has ignored the required level of consideration for the climatic change. Constantly and rapidly changing climate has proven to cause flood across the world. DEFRA noted that the government’s plan is based on the basic assumption that climate is not changing. This assumption appears to shatter the ground for the proposal as the change in climate in UK has been significantly evident. This issue was significantly identified by various analysts. For example, the Centre for Climate Change Economies and Policies clearly stated that this new plan is not sustainable as it lacks to consider the changing climate35. Also, Crichton (200836) has identified the increased importance of the climate change particularly after the Katrina Hurricane hit the grounds of United States of America. The disadvantage posed to the proposal from ignoring of the climate factor may increase the number of worse scenarios from considered one in 200 years to more. As the climate changes, the condition of land also transforms. Furthermore, continued development of land also increases the potential of floods and so the exposures of businesses and home in ways. While with the present conditions, nearly six million building (for any purpose) are exposed to the flood risk in current settings. Due to climatic change, this number would then increase, and the program has failed to address this aspect. The second disadvantage claimed to the plan is that it is only capable of attending the slice of the whole pie with ?180million. This number would inflate as the investment in the flood defaces require an increase of ?20 million in order to encompass the impact from climatic changes37. The proposal is subject to scrutiny by the parliament. The Government representatives self state that the proposal is not able to generate the required value that a usual public money spending can do. With these reservations, the government representatives are also not sure of the response of the parliament on these factors. This has increased the vulnerability of the MoU. Legal weakness of the MoU is also identified in the Friends of Earth’s release on December 5th 2013. The release notified that levy related regulation once the amount required for the fund after accounting for the climatic change, is not provided with the required detail. This shall not be left as an oven avenue in the high cost project and must be given due consideration by the parliament before implementation. Similar release has also notified the non-clarity about the transition of the program to incorporate the risk reflective prices. There is non-clarity on the fact as the five years period is over or on the expiry of the entire Flood Re deal, the price charged as premium will be increased. The community claims that this rise in the price would be against the claimed objective of providing affordable insurance. Also, there is non-clarity that if the referred rise in premium is for refraining people from investing in high-risk locations. This is defined as the important way of controlling disaster of flood38. Therefore, the non-clarity has put the stated objective questionable. The approval and implementation of the project of Flood Re will increase the cost of insurance to others as well. Therefore, this will require the readiness of the remaining household insurance policy bearer to pay for the others. Non-clarity on this has added to the vulnerability of the project. One of the most critical factors that are expected to hamper the performance of the Flood Re will be the fact that Office of National Statistics will consider section of the Flood Re as the tax. This will create complications as to determine Flood Re arrangement as private or public sector entity for the accountability of the public owned resources. This non-clarity is another disadvantage associated with the MoU39. All the referred disadvantages defined above constitute of aspects that can be resolved. As the mutual consent has been determined and agreed upon for the MoU, further elaboration on the matter can also ensure the resolution of most of the identified disadvantages. Furthermore, effective endorsement by the parliament will contribute to the concreteness and strength of the proposed plan. RECOMMENDATIONS Many people around the world, lost their lives and homes in floods and other natural disasters. It is logical that such natural disasters can neither be controlled nor they can be anticipated. Therefore UK government should be prepared for flood, and try their best to reach to a settlement with the insurance companies, to create the most suitable and beneficial insurance mechanism for both the citizens and the government of UK. The UK government took the first step towards creating a stronger mechanism, to secure properties against floods, which is considered to be one of the most catastrophic natural disasters. However, taking under consideration the advantages of Flood Re, it is extremely crucial to state that Flood Re should be amended in certain areas. The main aim of the below recommendations, is to create a more effective governmental mechanism, that shall enable the citizens of UK to secure and insure their properties against flood, without baring the total cost of such natural disaster. Some recommendations are presented below: The equation of premium price to the affordability level will reduce the resistance of people in property building at high flood risk zones. Consequently, the pool size needs to be expanded. This barrier can be removed or controlled by conditioning the insurance with air brick covers and the flood gates40. This will provide the double benefit; first, the policy holder will be signaled about the high risk in the area maintaining the resistance to develop property in such areas. On the other hand, it will help in maintaining the size of the pool while supporting affordability. Clarity in the program is the most important recommendation that will improve its effectiveness and applicability. For instance, the matter of transition after 20 to 25 years has not defined its system. The presentation of clear system with which the benefit of reduced premium on high-risk areas will be taken back, and it will also serve as the barrier to overflow of property development in that areas. Furthermore, it shall provide a clear direction to the insurers to define future system of insurance. So the cost incurred on the implementation of the program is actually materialized into profits into longer terms. Environment Agency reports that investment in the flood defence by ?1 save the economy from the unwanted expense from the flood disasters by ?8 while protection level investments reduce it by ?541. However, this plan will require the cost to increase, which is to be paid by the others. Hence, these issues need to be resolved with barriers that restrict the insurance policy with some conditions with respect to environment protection at a broader level to insurer. Also, it must condition the policy benefit to those incurring cost of property level protections. Hence, these measures are important in limiting the cost of few to be paid by the others. Additionally, it will save others from consistently carrying the burden of the few living in high-risk areas. Also, this will create a barrier for the free riders as such class would be signaled that this benefit of affordable premium is not for free. Already noted above that welfare benefit of the program is high while the economic benefit is around at the deficit of 30 pence for every ?142. Therefore, creating incentives or barriers to expand this pool will limit the addition to this deficit. Paying the full cost of the claim to the insurance policy holder except the standards additions shall also be limited to a certain level43. This shall increase the pressure on the policyholder for controlling the cost of the claim. It is deemed necessary to acknowledge that almost all the aspects mentioned above in the improvement section are based on making Flood Re more economical for the Government. Moreover, the improvements are presented to pass all the benefits to the property holder in the high-risk areas. It is also intended for controlling the undue expansion of development in the high flood risk plains. CONCLUSION Floods are among those natural disasters that have lasting impact on the lives of people as well as economies for the long term. The role of insurance is increasingly discussed in this context in order to overcome the destructive impact of floods to some extent. Locations with higher hazards of the flood are posed with high risk and so are charged with high premium insurance. For benefitting people with such non- affordability, Association of British Insurers (ABI) and the national government have developed Flood Re: MoU. This essay has developed a critical assessment of the proposed MoU. For this purpose, the essay has outlined the need to sign such program, the key elements, advantages and disadvantages. The essay has also determined the recommendations for removing the criticized aspects of the MoU. MoU had clear intentions to benefit the un-affording people; however, some of its clauses had opened an avenue for the free riders. Also, the MoU has certain aspect with a high level of non-clarity. Upon identification of such factors, this essay has prepared recommendations so that MoU is able to generate the desired benefit as it has been aimed by the policy makers and government. 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