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Will climate change make your house uninsurable?

Jon Hughes, Rebecca Bole

29th January, 2009

The insurance industry is set to abandon two million British homeowners to the perils of climate change. Jon Hughes and Rebecca Bole report

Lloyds of London is one of the pillars of the business world. Since it came into being in 1688, the insurance house has facilitated world trade – by insuring shipping and other major ventures abroad. The establishment is famous for its Lutine Bell, which was salvaged from a bullion ship, and was traditionally rung to herald important announcements to underwriters and brokers. One stroke for bad news, two for good, the bell is recognised throughout the world as the symbol of the organisation whose fortunes are linked inextricably with natural and man-made catastrophes.

At the turn of the year, addressing the World Affairs Council in Washington, Lloyds’ chairman Lord Levene metaphorically rang the Lutine Bell – once. ‘Today the insurance industry faces the prospect of a $100 billion national disaster – twice the size of Katrina,’ he told his audience. ‘We need to wake up to the truth about catastrophe trends and radically review our public policy.’

The figures underlying his statement are stark. Since the Seventies, insurance losses have risen at an annual rate of around 10 per cent, reaching $100 billion dollars in 1999. Losses of this scale are ominous, meaning that the total damages bill will double every decade. If this trend continues – and Levene believes that it not only will, but that ‘we can only expect this to accelerate as climate change takes hold’ – it means that by 2065, insurance losses from climate change will equal the total value of everything that humanity produced in the course of a year.

And that is simply unsustainable.

In the aftermath of Hurricane Katrina, the Association of British Insurers (ABI) warned that home premiums in the UK could soar. At the time, ABI spokesman Malcolm Tarling said: ‘We’re not expecting an immediate premium increase directly as a result of Katrina, but the wider issue of climate change is beginning to have a very serious impact on insurers.’

It’s not simply weather events hitting Britain that could force up the cost of insurance, it is the nature of the industry’s global structure. Eighty per cent of the losses accruing from Katrina fell on foreign reinsurers, such as Munich Re, Swiss Re and Lloyds. These powerhouses underpin a system of domestic and commercial insurance that, by and large, we take for granted: to protect our homes and allow us to drive, and enable business to grow. Without insurance, the very notion of global trade becomes untenable. Yet the prospect of climate change – with sea-level rises and stronger storms – suggests that premiums could first become prohibitive, before becoming unavailable to many. We can already begin to see this happening in the domestic insurance market, with mortgage lenders and insurers threatening to withdraw their financial support for homes standing on flood plains in the UK.

Opening the flood gates

The Department for Environment, Food and Rural Affairs (Defra) estimates that today, 2.1 million properties – housing five million people in England and Wales – are at risk from coastal and river flooding. That equates to approximately £250 billion in assets. There are also 185,000 businesses situated on these flood plains.

In Britain, the value of weather-related claims reached £6 billion between 1998 and 2003 – twice the total in the previous five years. If carbon dioxide levels in the atmosphere double by 2080 (which is in line with ‘business as usual’ projections), then annual flood costs in the UK could increase almost 15-fold to £22 billion, according to the ABI report Financial Risks of Climate Change (FRCC). Premiums would reach such a level that it could spell the end of the era of home ownership.

In order to secure a mortgage in the UK, lenders require buildings’ insurance to be in place. This covers the cost of rebuilding your home should it be destroyed or damaged due to dangers such as flooding, subsidence or fire – the risks of which all increase in a warming world.

Currently, the insurance and mortgage-lending industries are not obliged by law to offer insurance to homebuyers. Market forces rule, and the insurance industry is essentially saying that the risks are too great or too  uncertain for it to want to be involved, almost at any cost.

Accordingly, the ABI, which represents 97 per cent of the UK insurance industry, has only committed to provide flood insurance until 2010. Jane Milne, head of property at the ABI, warned of developing housing on flood plains: ‘Some local authorities carry on as if flooding was not a threat. We cannot guarantee to insure some of the homes they build. This would mean no mortgages for these people.’

So, a considerable number of British homeowners can only feel safe in their beds for the next three years. Cold comfort, indeed.

A crowded isle

The government, insurers and mortgage lenders are all in agreement on the actual and potential threat of flooding in the face of climate change. Why, then, are the authorities allowing developers to throw rows of houses up on known flood plains, when we can only expect the flood risk to increase as the climate changes?

One reason is our national obsession with home ownership. For numerous social and economic reasons, people are demanding more housing to be built on our crowded island. We are running out of space to put these new homes and are resorting to risky sites to meet demand.

The Town and Country Planning Association estimates that we need 200,000 new homes a year, just to meet current levels of demand. With Defra and the Environment Agency (EA) rightly under pressure to avoid developing on greenfield sites, the outcome is that we are developing brownfield sites, the majority of which are located on flood plains.

The ABI report says: ‘In the past 20 years, over 350,000 residential properties have been built on floodplains in the UK, with more than 20,000 being built between 2002 and 2005.’

The government has designated four main growth areas to address the housing shortage in the South East – the Thames Gateway, Ashford, the M11 corridor and the South Midlands – each of which faces differing levels of flood risk, managed by defences of varying standards and qualities.

By 2016, 200,000 new homes will be built in the South East alone; and 89 per cent of the 120,000 new homes in the Thames Gateway development near London will be located in the tidal flood plain, below current low-tide levels. It is widely believed that flood defences in the area are inadequate.

A second ABI study, from 2005, Making Communities Sustainable, states: ‘The study shows clearly that the new developments in the Thames Gateway, Ashford, the South Midlands and the M11 corridor could increase the costs of flooding by more than £50 million each year if steps to manage potential losses are not taken – a figure that could increase tenfold once climate change effects are felt in full. But with some creative thinking and effective action, this additional flood risk in the growth areas could be reduced substantially.’

But creative thinking and effective action require a certain level of cooperation that is lacking in the field of flood defences.

Poor defenses

Defra has the ability to set policy, which can be adopted or ignored by the EA, local authorities, internal drainage boards, planning offices and developers. Defra allocates grant aid to help finance flood defence projects, but the local authorities and developers have to plug the gap from their own budgets.

In explaining its place in the scheme of things, a statement on the Defra website says: ‘Authorities have permissive powers to undertake works to manage risk – there is no statutory obligation on them to do so and thus no statutory right to levels of protection.’ Central and local government spent £600 million in 2005-2006 on flood defences, which in real terms is 40 per cent more than 1996–1997 spending.

In advice to stakeholders, Defra states: ‘Despite these large increases, we still have to prioritise proposed projects. Unfortunately, it is not possible to justify defending all locations to the same standard or at all in some cases.’

The EA has committed to spend £200 million on flood warning systems in England over a 10-year period up to 2012–13. By way of comparison, during the flooding of 2000, a total of 10,000 properties were damaged, at a cost of £1 billion.

Natural catastrophes are inherently unpredictable, and the insurance industry is based on predictability. To date, insurers have been able to capture past storm and flood data and use it to fairly accurately predict future activity, and price risk accordingly. They are now struggling to predict the effects of climate change on weather patterns.

In the United States, hurricanes Andrew (which struck Florida in 1992) and Katrina (New Orleans, Louisiana and Mississippi in 2005) were the heaviest recorded storms to hit land and caused human and financial devastation across the coast.

Correspondingly, the insurance value of properties in US coastal areas has doubled over the past decade – to more than $7 trillion, with Florida and New York both having a value of $2 trillion each. The combination of increased frequency and severity of natural catastrophes, rising asset values and increasing coastal population is a recipe for disaster.

If either location is hit by a hurricane of Katrina proportion, the impact on the global economy would be severe. As Lord Levene put it to his expert audience: ‘In New York’s case, almost $1.4 trillion relates to commercial property. Imagine the disruption to the economy if even 10 per cent of those businesses were forced to close down.’ Little wonder the insurers are heading for the hills and devising policies to force industry to adopt carbon neutral policies.

If the market will not provide insurance cover for people living in disaster-prone areas, governments will be forced to step into the void. But the state’s reaction is not always efficient, as New Orleans can testify.

According to The Economist in March this year, less than 3 per cent of the 115,000 families who have applied for help have received payments.

If the government of mega-wealthy America cannot look after its own in the wake of a natural catastrophe, we have just cause to be concerned. With the anticipated increase in natural disasters, governments would soon run out of money to bail us out. Before that, we face the spectre of millions of houses becoming unsaleable unless, that is, the government agrees to underwrite insurance policies.

In his speech, Levene said that Lloyds is now actively planning for a stormy future – before adding, ‘But I seriously question whether all policymakers, businesses and homeowners are doing so.’

Climate change is often viewed as an abstract or distant problem, but clearly its impact has beaten a path to your door and the Lutine Bell has tolled.

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Upside-down houses

Insurers are not so much concerned with a warning of floods, but whether these houses at risk are inhabited or not. In its FRCC report, the ABI is calling for homes to be built upside-down, with living accommodation and all electrics to be located on the first floor of the building. It also urges for legislation to force developers to take responsibility for flood defences. ‘Asking developers to pay could help to ensure that the market takes into account the full costs of development,’ it says.

If this were to happen, who would decide the level of flood defences? Would private developers be obliged to maintain flood defences? What recourse would homeowners have in the decades to come, if the developer were no longer in business? And would the housing be affordable to anyone but the most wealthy?

If insurers are withdrawing their capital from an area, it is a clear indication that the risks are too high for them to profitably cover it.

This article first appeared in the Ecologist June 2007

 

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