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The economics of flood insurance
The economics of flood insurance

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5.2 A surprising solution

By the early 2010s, it was clear that the UK government needed to take action to address the problem of flood risk. The market for housing on flood plains was clearly not working efficiently. Moreover, the previous agreements aimed at keeping private flood insurance affordable had only made matters worse by shielding households from the true cost of flood risk and so encouraging them to carry on buying on flood plains and developers to carry on building there.

A butterfly emerging from its cocoon.
Figure 13 Transition by design

In 2010, the government hosted a flood summit which set the direction for the policy options that would be considered. The government then set up working groups to refine the approach. The membership of the working groups was predominantly representatives from central government, local government and insurers, although evidence was also sought from other parties including community groups.

From the outset, the government saw the problem as one of insurance rather than managing the underlying flooding or building practices. As a result, all the policy options considered by the government were focused on how to prevent a sudden shift to risk-based pricing in 2013 and so ensure households at risk of flooding would have access to affordable insurance. In other words, the government was proposing to perpetuate the very system that seemed to allow the market failures in the flood-plain housing market to persist. The government explained this puzzling choice as follows:

To ensure the availability and affordability of flood insurance, without placing unsustainable costs on wider policyholders and the taxpayer. Doing so will provide assistance to those likely to be disadvantaged by a transition to more risk-based flood insurance pricing including any potential ‘unbundling’ of flood risk cover. A successful implementation would entail insurance terms adjusting towards risk-reflective pricing at a pace that allows choices to be made by policyholders facing long-term increases in insurance costs unless action is taken, and avoids any risk of instability in insurance, mortgage and local housing markets.

(DEFRA, 2013a, p. 1)

In other words, the insurance-based solution was intended as a stop-gap to create a transitional period during which the economy could adjust to the longer-term objective: the free-market solution of risk-based pricing.