When the levee breaks
Whilst the stalled talks between ABI and Government have recently re-started, in less than 8 weeks a substantial number of properties may suffer significant loss of capital value if their owners are no longer be able to obtain flood risk insurance.
Simon Chandler and Sue Highmore examine the way ahead as the ABI-government agreement on UK flood risk approaches expiration and a private insurance market returns.
Property owners, investors and lenders in the UK need to focus on a rapidly approaching threat to their security.
At the end of July 2013, the UK flood insurance market is set to return to being fully risk-based for most properties.
Insurers will be free to review their rates and excesses, impose conditions on cover, or refuse cover altogether, and no flood insurance may mean no mortgage for some. Either outcome is very likely to affect adversely the value of flood-prone properties, of which there are many more than people realise.
In 2009, the Environment Agency (EA) identified one in six properties as being affected by flood risk. This was twice as many as before, because surface water flooding (which tends to cause more than half the flooding in the UK) was factored in for the first time.
Prudent lenders should be thinking ahead so as to manage any adverse impact on the value of their security, particularly as the new regulator is focused on improving capital adequacy. Institutional investors and developers need to factor flood risk into their stock selection, as they will not be immune from the pending insurance changes.
Free market
The protracted discussions between the government and the Association of British Insurers (ABI) to craft a scheme offering accessible and affordable flood insurance for homeowners (and their lenders) may yet produce a solution. However, that scheme is unlikely to cover commercial property or new builds, and so will leave a significant proportion of properties in a totally free market.
The desire for a free market is unsurprising. Losses caused by flood and storm damage in recent years have been significant at over £3bn in 2007 and £1.19bn for 2012, which was the second-wettest year on record. Urbanisation, inadequate and poorly maintained drainage systems, and past lax planning policy that allowed building in risk-prone areas – all these exacerbate flooding. With more extreme weather events and reduced public expenditure on flood defences, insurers’ appetite for the highest risk properties is naturally constrained.
The long-term impacts of climate change will require similar adjustment to the business model for flood insurance in many countries. The exceptions will be where the state bears the cost of flood damage, which is not something that the UK government will embrace. Its view is that property owners must be well informed and take steps to protect themselves.
On the agenda
Flood risk was not high on the agenda until recently, partly because identifying the true flood risk profile of an individual property was difficult; but now there is increasingly robust data. The main reason no one worried was because of a long-standing deal between the government and the ABI (the Statement of Principles), which offered homeowners and small businesses access to flood insurance at relatively stable rates, even if their property was at risk. This expires in July and will not be renewed.
So, what should the prudent lender/investor do? The first step is to make a simple screening of the property’s flood risk profile. Basic desktop searches, which examine data from the EA and commercial data on surface water and other risks, are relatively cheap in comparison to the potential loss from flooding (£30 upwards for homes and £75 upwards for commercial properties). Quality searches include expert analysis of the overall risk.
For new loans, lenders should commission a specialist flood risk search as part of their due diligence (which is usually done at the borrower’s expense). For existing portfolios, depending on their size, lenders should consider checking the flood risk of all or a sample of the properties, to test the effect on overall portfolio value.
If a search reveals potential problems, it may be possible to renegotiate the price or loan-to-value ratio, spend money on protecting the property from flooding, or to use specialist brokers to access flood insurance. The one thing to avoid is doing nothing, because this issue is not going away.
This blog was written by Simon Chandler and Co-authored by Sue Highmore at Practical Law Company.