draft Flood Reinsurance (Scheme and Scheme Administrator designation) regulations 2015 DRAFT FLOOD REINSURANCE (SCHEME funding and administration) REGULATIONS 2015

Barry Gardiner Excerpts

Tuesday 15th September 2015 General Committees

[Barry Gardiner (Brent North) (Lab)]

It is a pleasure to rise to talk about these regulations under your guidance, Mr Nuttall. I do not intend to oppose either of the regulations before the Committee, but I must highlight two serious concerns that I have with the transition to risk-reflective pricing that the scheme is designed to achieve.

First, it is likely that the transition will compromise the availability and affordability of flood insurance, and that needs to be recognised. It is also likely that Flood Re will prove to be a waste of public money. Before I go to the specific points about the wording of the regulations, I want to put those remarks in context.

Flood risk is increasing because of climate change and new developments in flood-risk areas. Awareness of flood-risk households, where the risk is above one in 100, has declined. Government spending on flood defences fell over the past Parliament, although by setting a six-year framework the Government claimed to have spent more than the previous Government, though that was, of course, over a five-year period. It is set to fall further in this Parliament.

The risk of flooding is increasing and more properties are being built in high-risk areas. There is declining spending on flood-risk reduction and declining awareness of flood risk. That is the context for the Flood Re scheme. The possibility of loss, damage and injury from flooding is, therefore, increasing—in every sense, flood risk is increasing.

The scheme does not address the rising cost of flood risk for affected households or the public purse. The Government voted against six amendments that we tabled in Committee on the Water Act 2014 that would have required Flood Re to reduce the cost of flood risk. Those amendments would have required the scheme administrator to take account of actual and projected future flood risk as set out by the Committee on Climate Change and the Environment Agency. The Government refused to do that.

We would have given the scheme administrator powers to require flooded households to repair to a higher flood-defence standard. The Government say that that might be considered at the first review. In my view, those powers should be with the scheme administrator from the beginning and I believe that the industry would probably share that view.

The amendments would have required that the scheme administrator had to increase awareness of flood risk among policyholders, and actually take a proactive stance on liaising with policyholders on those matters. The scheme administrator would have been required to ensure that insurance is available to households that are unable to afford insurance on the free market.

The Government declined to support those amendments. I was delighted to hear that the Minister had spoken to Lord Krebs earlier today; when we tabled those amendments, it was Lord Krebs, as chair of the adaptation sub-committee of the Committee on Climate Change, who provided the supporting evidence. I am keen to hear what Lord Krebs had to say to the Minister about those aspects of the scheme. Of course, that view was also supported by evidence from the London School of Economics at that time.

As I said, our amendments were disregarded; the Government are using this publicly funded flood insurance scheme to insure against the cost of their own potential failure. As investment in flood defence is cut in line with the Government’s plans, thousands of families may find themselves stuck in homes that become more and more expensive to insure. Climate change has already increased the frequency and severity of flooding, and the costs are rising. This publicly funded scheme allows the Government to transfer these costs on to households across the country, pushing the cost of climate change on to the most vulnerable. That is what risk-reflective pricing means in practice.

I return to my two specific concerns with the regulations as they stand. The public consultation on Flood Re, which ran from 22 July to 16 September 2014, stated that the aim of the proposed flood insurance scheme would be

“to ensure that domestic property insurance continues to be widely available and affordable in areas of flood risk, without placing unsustainable costs on wider policyholders or the taxpayer”.

However, there is no mention of the availability or affordability of flood insurance in this enabling legislation. They are mentioned in the explanatory notes and were referred to many times during the debate on the enabling legislation, but they are not in the regulations, so it is not a duty of the scheme to ensure the availability and affordability of flood insurance.

Many responses to the public consultation counselled that to ensure availability and affordability, the scheme must be required to work in the public interest, with that being defined in the regulations. It is not defined in these regulations. Many responses, including that from the London School of Economics, also warned that the absence of a transition plan would threaten the availability and affordability of Flood Re.

It was my view, and still is, that a Flood Re transition plan should be produced by the Government, in consultation with the scheme administrator, the industry and the Committee on Climate Change. The primary delivery body for the transition plan should be the Flood Re managing agent, the scheme administrator, and DEFRA should take responsibility for reviewing their performance against the time-bound goals of the transition plan. Transition needs to be planned within the context of the overall flood risk management strategy, including details of future investment levels.

The decision to delegate transition planning to Flood Re, as currently proposed, is really a mutually convenient abdication of responsibility. The Government do not need to assess the likely efficacy of Flood Re against their flood risk investment plans, and the insurance industry can be confident that it can deliver its only objective: to manage the transition to risk-reflective pricing. I do not mean to labour the point, but the industry has simply got to produce risk-reflective pricing, which, if the risk goes up, may be as high or much higher than what is today deemed to be an unaffordable cost.

Everything depends on the amount of money that the Government are prepared to put in. This scheme is a way of avoiding the problem and any need to make the uncomfortable acknowledgment that the price that reflects increased risk will be greater where the risk of flood becomes greater as a result of lower Government investment in flood defences, increased building on the flood plain or adverse climate change. That is the fear. Quietly and stealthily, the Government have delivered a new flood tax.

The adaptation sub-committee of the Committee on Climate Change suggested an amendment to the levy arrangement, which I believe the Government should have considered. The amendment would reduce the cost and the opportunity cost of the Flood Re funding arrangements.

The sub-committee also suggested that a more efficient model would be for Flood Re to collect a primary levy and to build reserves, but not to hold reinsurance at all. Instead, claims in excess of reserves would be mutualised—spread between the relevant insurers—on an annual basis via the ad hoc levy. If that resulted in a large claim on insurers, they would be able to call on the existing reinsurance treaties that they are required to hold in any event. That approach would have significantly reduced the costs of Flood Re and, in my view, it would improve the value that the public purse was getting from the scheme.

In summary, Flood Re could help to reduce flood risk, the cost of flooding and the pain and suffering of the households that the Minister eloquently discussed at the beginning of this debate. It does not do those things currently, and I fear that it may well waste public money that could be better spent on reducing those flood risks by increasing our flood defences.

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[Rory Stewart]

I am grateful for that statement. I hope that right hon. and hon. Members will be able to communicate to their constituents and those concerned with flooding not only that we have managed to get to this stage, but that we are looking forward to next spring when the scheme is formally launched.

I want to touch briefly on the various points and criticisms made by the hon. Member for Brent North. I find some of them a little bewildering, and I would like to tease them out a bit more. His arguments seem to focus on four areas: awareness, affordability, the transition plan and the model of insurance.

To reassure him on awareness, an obligation is imposed through the regulations on Flood Re to communicate with the insurance industry and on the industry to communicate with the policyholders that they have entered the Flood Re scheme and that by definition they are therefore in the approximately 2% most vulnerable homes. Through the Environment Agency and our investment in new technology, we are absolutely committed to increasing our contact with people in the most vulnerable homes.

We have also been meeting in detail with different parts of the industry that are interested in providing flood resilience measures to individual households. There should be a potential market, and we need to develop it. Just as house and contents insurance has delivered developments in burglar alarms and other protective measures, it should be possible for flood insurance schemes eventually to drive a movement towards people taking resilience measures to drop their premiums. That is where we need to get to. We need a thriving, vigorous industry with a reasonable basic standard that can be offered to a household, saying, “If you do, x, y and z, the insurance industry will recognise that and drop your premium.”

[Barry Gardiner]

I am grateful to the Minister for his clarification of the points. Given that he believes there is not yet a certifiable standard for resilience measures to be put in, why does he seek not to give the power to the scheme administrator and Flood Re at this stage? They believe that such a facility is in place and that they can insist on resilience measures being put in as a condition of reinsurance. Why not give that power so that the industry can decide how it uses it, when it uses it and whether the market is ready to provide the appropriate benefits or not, rather than waiting for the Government to do a review and then decide whether they want to give the scheme administrator those powers?

I understand the problem. It may be that the market is not yet ready, but surely it is better to give the power to the scheme administrator straight away, so that the insurance companies can take the necessary action the moment they are ready, rather than waiting for a Government review.

[Rory Stewart]

There are essentially three separate problems with that proposal. The first is that the Flood Re administrator has no direct relationship with households. As the hon. Gentleman is aware, the Flood Re administrator’s relationship is with the insurance industry, and the relationship of the individual insurance companies—for example, Direct Line or Axa—is with the individual household. Whatever measures one is trying to put in place, there needs to be an interaction between the insurance company and the individual household.

The second issue is around the nature of the financial regulations that set up Flood Re. Flood Re, like all reinsurers, is only permitted by financial regulation to carry out the business of reinsurance and related operations.

The third issue—perhaps the most important—is that within three months, Flood Re will produce a transition plan and within two years those resilience measures will be in place. However, in the end it is primarily the responsibility of Government to work with Flood Re, the insurers and the households to get those measures in place; the constraint on that, as the hon. Gentleman has indicated, is that the industry is not yet sufficiently developed to offer a standardised package. A burglar alarm is a much more straightforward thing.

Every one of these properties—not quite every one, but many of them—are in quite difficult, unique situations. The insurance industry is not yet in a position to be comfortable saying, “This exact measure on your door will reduce your insurance premium by £50”, in the way that it can with burglar alarms. It will take some time for what is basically a structure of small and medium-sized enterprises to be able to develop those products for the insurance industry.

The way in which the hon. Gentleman and I can engage in this process most directly is through the measures taken by the Environment Agency and, for the hon. Gentleman, more specifically through Parliament, to which Flood Re is accountable. It will be through Parliament’s review of that three-month transition plan and the two-year actions that we will be able to put in place the measures that we need over the next 25 years.

Of course, the hon. Gentleman is right to say that the fact that the period is 25 years should not mean that we all go to sleep for that time, do nothing and end up dropping off the edge of a cliff. Twenty-five years should be able to give us the right path to get those proper structures in place. It is Parliament’s responsibility to stay on top of that issue.

The second thing that the hon. Gentleman touched on was the question of affordability. He is correct that these statutory instruments do not deal with the duty of affordability. However, he will be aware that the duty of affordability is contained in the Water Act 2014, the debates on which he himself contributed to. Therefore, I do not believe that the duty needs to be in these statutory instruments.

Again, a statutory obligation is imposed through these statutory instruments to push forward with a transition plan. The most sophisticated arguments that the hon. Gentleman has made are around the question of mutualisation and insurance.

[Barry Gardiner]

There is something I would like to get on the record, Mr Nuttall. Importantly, the Minister has said that he believes that as the duty of affordability is latent within the 2014 Act, it need not be in these regulations. I do not want to tie him down, because I want clarity, but I would like him to write to me, perhaps after this debate, to set out absolutely clearly that that is the position. That would be extremely helpful.

[Rory Stewart]

I will be delighted to. To clarify, we have to be very careful about what we mean by affordability. Clearly, under both domestic and European legislation, we are not allowed to fix prices. This is a market mechanism. We are relying on competition in the market to operate, the theory being that there would be no reason for an individual insurance company to place a £250 contract with Flood Re if it was not necessary to do so, because a competitor insurance company would be able to offer the same insurance for £50 to the householder and there would be no recourse to Flood Re.

All our affordability calculations are predicated on the assumption that normal market competition will operate. The affordability works through setting the individual premiums and guaranteeing that the £180 million pot will stand behind those individual payments, capping both the premium payment and the excess payment. That is its basis.

[Barry Gardiner]

I am really grateful to the Minister for engaging in this way. I understand what he says about affordability. On his definition, as long as the market is operating to have competition in place, the result is affordability. However, it is important to recognise that the risk of climate change is increasing and the severity of floods may also increase.

Although, in the purely technical sense that the Minister outlined, if the market is operating people are likely to get the lowest market rate, the ordinary householder may not experience affordable insurance premiums because the risk is increasing and the Government are building on the floodplain. In fact, all the industry has to do is ensure that the price reflects that risk.

[Rory Stewart]

From the insurance company’s point of view, in the case of the households that are most at risk, Flood Re provides the ability to lay off the flood component of its household and buildings insurance, which for a basic rate council tax payer is in the region of the £220 to £250 mark. There would be no reason for an individual insurance company to make the flood component of its insurance exceed that amount—that is the purpose of the £180 million pot.

I agree, however, with the hon. Gentleman on the basic questions with which he began, and we certainly need to look at this during the next 25 years: building on floodplains, climate change and increasing flood risk. That will have an impact right across the industry.