The economics of flood insurance
The economics of flood insurance

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The economics of flood insurance

5.6 The government’s policy decision

The government’s social CBA found that the Flood Re scheme was estimated to have a net cost to society of -£188 million (DEFRA, 2013a). There was a large amount of uncertainty surrounding this estimate. Various assumptions were altered to see what impact that would have (called a sensitivity analysis). In the worst case, the cost climbed to -£601 million, but in the best case there could be a net benefit to society of £224 million. Moreover, other options considered looked more favourable on the basis of the CBA.

Based on the CBA alone, Flood Re would not be obvious choice and the government’s decision has been criticised (see, for example, Harrabin, 2015). However, the Flood Re scheme which is due to run for 25 years, until 2039, was justified by the government on the following grounds:

‘The government’s preference is to work with the industry to secure the affordability and availability of flood insurance...Flood Re protects high-risk properties and makes insurance widely available. This sits well within insurers current business models and the support of the industry would help to ensure a smooth transition in the interim period. Despite the ‘best estimate’ monetised benefit–cost calculations being unfavourable, there are economic and particularly social factors not fully reflected in this, in particular the importance of providing certainty for individuals, and the avoidance of potential impacts on local housing markets, from concerns about the availability and affordability of insurance. The industry estimate that Flood Re will reflect the existing cross-subsidy in the market and in the short term bills will not increase in general. Over the long term (as a transitional policy) a gradual increase in bills (in response to a reduction in subsidy) for those households at risk will cushion the move to a free market, and risk reflective pricing.

(DEFRA, 2013a, p. 31)
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