MIND THE GAP: FUNDING FOR UK’S FLOOD DEFENCES
This is our second paper on flood defences in the UK. The first paper published on 2nd of May 2016 focused on risk management and this paper discusses methods of funding for flood defences.
The 2015/16 winter flooding cost the UK £2bn, of which £1.4bn was paid by insurers. The Government has committed to spending £2.3bn over next six years to increase flood resilience. In the 2016 budget, the Chancellor allocated a further £700m for flood defences. These are big numbers and are unfunded. A fresher bold look is necessary and the outlook in the UK is looking good.
1. Insurance Industry
The launch of Flood Re reinsurance (www.floodre.co.uk) in 2016 is timely. Although it is not a panacea for managing flood risks, it is an important part of the solution that includes further flood defence investment and construction, implementing greater resilience in the upkeep of flood damaged property and most importantly cessation of construction on flood plains.
Flood Re enables insurance companies to insure themselves against losses because of flooding. Unlike other reinsurance companies, it is a not-for-profit fund, owned and managed by the insurance industry and designed to last 25 years. It is also publicly accountable. Flood Re’s aim is to promote availability and affordability of flood insurance to those who own and live in properties in flood risk areas. Establishing it requires Government legislation and it is the first scheme of its kind anywhere in the world.
Forty insurance companies have signed up for an annual protection of £2.1bn. The scheme caps the excess insurance paid to householders and expects to cover 350,000 homes. The insurers pay a levy and then pass the excess risk to Flood Re. It is hoped that a competitive market will slowly evolve when the insurance industry better analyses flood risk. The scheme excludes commercial properties and those built since 2009.
Flood Re and other insurers need to have assets that are correlated to flood risk liabilities, in addition to investing in assets that deliver returns. We believe now is the time to create an asset class which will help the industry to partially hedge flood risk liabilities arising from:
• Highly-populated areas and high-value housing stock exposed to flooding
• Repair costs to withstand repeated flooding
• Houses built on high-risk flood plains.
2. House Builders
The Environment Agency estimates that 10,000 houses are built on flood plains. Moreover, there are no known incentives to stop building on flood plains. House builders’ assets and liability trade-off is different to the insurance industry, but they may have similar needs to hedge their assets (current and future housing stock) against flooding.
3. Local Business exposed to Flooding
Commercial property is excluded from the Flood Re scheme. Where there are small businesses that face difficulty in getting property insurance because of flood risk, the insurance industry estimates nature of this problem is on a much smaller scale nationally and is of a different nature to those faced by domestic properties. These properties need specialist flood protection through one-off or Government schemes such as partnership funding and incentives on business rates and corporation tax.
Flood Defence Infrastructure Bond
The Government should issue a Flood Defence Infrastructure Senior Bond, which pays a variable coupon and with a 25-year maturity. The Bond should help to hedge the flood liabilities of the insurance industry, especially the ultimate reinsurer, Flood Re. The coupon of the bond will be variable and calculated using flood risk analysis to broadly reflect the incidence of extreme floods. The infrastructure debt should be priced so that yield should be attractive to investors and match liability profile of the insurers including Flood Re. The 25-year maturity was chosen to match the duration of the Flood Re scheme, but longer duration may be required to attract investors. The proceeds of the bond should invest in flood risk areas most at risk as categorised by the Environment Agency. They are:
Project 1: Thames Valley Flood Defence Mater Plan
Project 2: North Kent Flood Defence Master Plan
Project 3: River Ouse Flood Defence Master Plan
Project 4: River Arun Flood Defence Master Plan
Revenues via a Levy on House Builders
The annual coupon for the bond will be financed by a levy on the House Builders. This could be calculated as follows:
a) Fixed levy house builders based on the market value of the housing stock;
b) Variable levy on housing stock built on flood plains by the house builder in the catchment areas covered by flood defences.
We propose the Government gauge the demand for the Bond by consulting Flood Re and the other participating insurance companies. There could also demand from infrastructure funds, house builders and global companies operating from impacted areas (e.g., Pfizer Inc. contribution to Sandwich tidal defence).
Commitment by the Government
In return for funding from the infrastructure bond and the house builder levy, the Government should:
• Change building regulations so that the material used for repairs at flood-damaged properties can withstand future flooding. In this way, the UK will be able to a build housing stock, which is better resilient to future flooding.
• Improve risk management capability by creating a national risk framework. Improve crisis management similar to Netherlands where flooding is treated as a national security issue. Improve resilience planning and testing at least every 8 to 10 years.
• Improve flood risk education in schools to improve risk awareness culture, especially difference between flood protection and flood defence and sustainable solutions.
Government policy has brought flood risk strategy to a high standard. The current Flood Resilience Review is a good opportunity to revisit these structures and use innovative methods to fund flood defences. Failure implement these measures will result in a missed opportunity for the country as a whole.