The high risk of living on a low flood plain

1st December, 2012

“Flood talks between the government and insurers have reached ‘crisis point’, the industry association said, as torrential rain in parts of England and Wales left three people dead and forced hundreds from their homes.”, November 26

I’m not sure this is really an insurance problem.

How could it not be an insurance problem?

It seems to me that there are three kinds of hard-to-insure risks. First, there are unimaginable events, “unknown unknowns”, if you like. Yet floods are all too easy to imagine. Then there are risks that are subject to what economists call adverse selection. To take an extreme example, imagine a town ruled by some all-powerful Mob. Nobody in this town is ever robbed without warning. The Mob will be sure to let you know what’s coming to you and why they think you deserve it.

Extreme case, I think.

Yes, but you can see that no insurer would touch the place, because the only people to demand insurance would be those who already know that robbery is inevitable. A similar but less extreme argument applies to health insurance, and it certainly applies to private unemployment insurance: you know a lot more about your health and employability than any insurer, so if you come shopping for insurance, the insurer might want to know the reason why.

But that doesn’t sound like a good description of flood risk.

Quite so. Now the third kind of hard-to-insure risk is stuff that’s expensive and happens quite often. I’m trying to buy a house, I’m nearly 40 and so I’m trying to buy insurance for my family in case I die or become too ill to work. This is perfectly possible: it’s just expensive, because it’s not unusual for middle-aged men to get seriously ill. This sounds like a much better description of allegedly uninsurable homes: if there is a one in five chance of a flood, and a flood is going to cost £50,000, don’t expect to pay less than £10,000 a year for flood insurance.

But that’s unaffordable for a lot of people.

Yes, but unaffordability is not uninsurability. It’s insurable but expensive.

You’re splitting hairs.

I don’t think so. If these homes actually were uninsurable the government would need to step in and cut some kind of deal with the insurance industry – exactly the kind of deal that has lasted for the past few years and seems about to unravel. But if the problem is unaffordability, trying to solve it by cutting a deal with the insurance industry is just a way of obscuring what is really going on. The real solution is simple and stark: the government needs to decide whether it wants to pay people thousands of pounds a year to live in high-risk areas or not.

And if not?

If not, then people who currently live in flood-risk areas will see the price of their homes collapse.

To what level?

To whatever price would tempt people to live somewhere that was not only prone to distressing and disruptive floods, but was also hugely expensive to insure. Which in extreme cases will be “zero”.

Pretty harsh.

It is. So there’s a good case for the government abandoning any attempt to arrange affordable insurance, while simultaneously making a one-off payment of hundreds of thousands of pounds to anyone who owns a home in a high-risk area. The price of those houses would collapse but with cash in their back pockets people could decide whether to stay or go.

A bit utopian.

Yes, I know. It won’t happen. But at least it focuses the mind. There is a general problem with many kinds of social protection – anything from unemployment benefit to the National Health Service – which is that in seeking to protect people from all sorts of unpleasantness, you are also providing an incentive to seek unpleasantness out. Unemployment benefit is an incentive to be unemployed; free healthcare is an incentive to get sick.

But people don’t get sick deliberately.

No, not often, although they might take less care of themselves than they otherwise would. I’m not saying that this kind of social insurance is a bad idea; I don’t think it is. But it does have unwelcome side effects. And in the case of flood insurance, where people have a choice about where to live, and more to the point planning authorities have a choice about where to approve new building, it is not a good idea to hide these side effects under the sandbags.

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