Water Bill

Lord Ashton of Hyde Excerpts

Monday 27th January 2014 Lords Chamber

[Lord Ashton of Hyde (Con)]

My Lords, I am pleased to support the Bill because of the increased competition it will bring to the water sector generally. I am glad that Her Majesty’s Opposition in another place welcomed this aspect of the Bill. In talking about competition, I will concentrate on Part 4 of the Bill concerning flood insurance. Here, I must declare an interest, or a residual interest, because I was, until June, the chief executive of a Lloyd’s insurance company and a London market reinsurance company, which was a member of the ABI. Although I am not now an employee, I am still the subject of various restrictive covenants. I am also, like my noble friend the Minister, the owner of a flooded house, but, fortunately for me, it was occupied by my father-in-law.

Making flood insurance available and affordable to all, as is the intention of the Bill, is a common problem in many countries and the temptation to interfere in the open market is fraught with difficulties. In the United States, for example, the National Flood Insurance Program was created in 1968 and allows property owners in participating communities to buy protection from the Government. The problem with government schemes is that the correct risk-adjusted rate is not charged, so the program is now about $30 billion in deficit. When you try to correct it, as the Biggert-Waters Act of 2012 was seeking to do, you get huge rate increases. In this case, there were increases of up to 400% for some home owners.

Having said that, there are huge problems for those households which, through no fault of their own, live in areas that are susceptible to flooding and for which this is a deeply worrying matter. It is surely right that there should be temporary help for those households while, at the same time, acknowledging on the face of the Bill the intention to,

“transition to risk-reflective pricing of flood insurance for household premises”.

The Bill stipulates a 25-year transitional period. Flood Re is a unique solution and, after many months of negotiation, it has the advantage of being supported by the insurance industry, as represented by the Association of British Insurers. It will be an industry-owned mutual classified as a public body. In agreeing to this, recognition should be paid to the insurance industry for agreeing to maintain the statement of principles until Flood Re is up and running. The industry has an incentive to make the new company work and avoid the flood insurance obligation, which is also in the Bill.

Flood Re will be an improvement because it makes affordable insurance available where it is not today. All insurers, new and old, are on a level playing field. Of course, there is nothing to stop an insurer keeping high-risk flood properties and not ceding them to Flood Re if it can get what it judges to be the correct risk-adjusted rate. That happens in many countries. There are, however, a number of potential problems, which will no doubt be addressed in Committee.

The first is the danger that, in the early years, a large-scale flood or series of floods over several months could exhaust Flood Re’s resources. That is a possibility although an extremely remote one. Like all insurance companies in the Solvency II world, Flood Re will be capitalised to a one in 200 level. In other words, it will have enough resources with an appropriate level of reinsurance—and assuming that the internal model is correct—to cover 99.5% of the losses that it could ever expect to face. This takes into account possible model errors and a host of other variables, which have to be documented and validated before the internal model is approved by the PRA. One in 200 is far more remote than any recent losses. Even the floods of 2007, which would have had an estimated £400 million cost to Flood Re, would have had to be six times worse—to be accurate, the reinsured loss amount would have to be about six times higher—to exhaust the likely level of the reinsurance programme.

In the event of a shortfall, the member insurance companies could be asked for a top-up levy to enable Flood Re to pay out its contractual aggregate limit after which, like any reinsurance arrangement, the liability falls back on the insurance companies that wrote the original business. The insurance industry has accepted this risk. While not incurring any contractual liability, the Government have affirmed in the memorandum of understanding with the industry that they bear primary responsibility for dealing with a flooding event with a greater than one in 200 return period.

Secondly, there are exceptions that Flood Re will not cover. These are mainly areas that are not covered anyway today by the statement of principles, such as houses built after 2009, to which the noble Lord, Lord Cameron of Dillington, referred, commercial properties and SMEs, and potentially genuinely uninsurable properties, although this will not happen at the outset of the scheme. If the intention is to move to free-market pricing, albeit over 25 years, it would surely be odd to increase the scope of the market intervention at the outset.

Thirdly, there are many details to be addressed before Flood Re can begin operations, which makes mid-2015 an ambitious target. The reinsurance protections will have to be bought in the open market. Flood Re will have only a finite amount of ceded premium and levy available to pay for that reinsurance, and whether or not the market will provide the required aggregate limit at an acceptable price remains to be seen. The fact, too, that it has to be bought under public procurement rules makes the exercise more time consuming. June 2015 is an ambitious timetable, with more than 170 open work packages to complete. Anyone who has been involved with Solvency II preparation, the validation of an internal model and the approval of the very onerous documentation requirements will know that is not trivial and that timely authorisation from the PRA should not be taken for granted. Nor, by the way, should EU authorisation for state aid, and I would be interested to hear from my noble friend the Minister when he anticipates that this will be forthcoming.

Finally and, to me, worryingly, it seems that Flood Re is going to be the most regulated company in the insurance market. It has been set up deliberately as a private regulated insurance company, but there will also be public arrangements for oversight due to the levy that will raise an estimated £180 million. Because of that, all the panoply of public supervision will be imposed in addition to the normal regulation that Parliament and the European Union have seen fit to impose. Actually, £180 million is really not a great deal of money—to put it in context, insurance premium tax alone raises more than 16 times as much. Nevertheless, as a result, Flood Re will be regulated by the PRA and the FCA. The National Audit Office will assess the economy, efficiency and effectiveness of its operation. There will have to be a responsible officer directly accountable to Parliament. There may well be scrutiny by the Public Accounts Committee. Defra will be held accountable to Parliament because Flood Re will be part of its accounts, with obvious implications for Flood Re’s compliance and governance costs. Commenting on this, Defra’s briefing note states:

“This proposed approach aims to strike a balance between the requirements of accountability to Parliament, and the need for Flood Re to be able to operate as an integral part of the insurance market”.

I hope that the future CEO of Flood Re, who is yet to be appointed, agrees.

Nevertheless, these concerns, which can be met, should not detract from an innovative solution to a genuine social need: to achieve affordable insurance for some 500,000 homes in the country while at the same time preparing the way for genuinely risk-reflective rates.