Britain trying to Spread the Risk and Cost of Floods to those who Don’t Live in Floodplains

Posted by PITHOCRATES - December 9th, 2012

Week in Review

Insurance manages financial risk.  One of the earliest forms of insurance was marine insurance.  For it was very risky shipping things across the ocean.  Sometimes storms damaged ships.  Requiring the crew to jettison some cargo to make the damaged ship seaworthy.  So all shippers paid a little extra to provide something we called ‘general average’.  So when the ship reached its destination those who still had cargo aboard could sell it.  While those whose cargo went overboard to make the ship safe for everyone else got this insurance money.

Those who were taking a risk bought insurance to manage their risk.  So that in the event of a loss they mitigated their financial losses.  This is a very important fundamental of insurance.  Those who take a risk pay the costs of managing that risk.  A blacksmith working in an inland community didn’t contribute to the general average.  Because he had no risk exposure on that ship.  So to reiterate, risk takers pay the cost of insurance to mitigate their potential financial losses.  Which the free market does brilliantly.  Except when an activity is so risky that everyone exposed to a risk will suffer a loss.  As in flood insurance (see Flood insurance warning by MP Jonathan Evans posted 12/9/2012 on BBC News Wales).

The existing deal, reached in 2008, obliges insurers to provide cover for high-risk properties while the UK government continues to fund improved flood defences…

The Association of British Insurers (ABI) is calling on the government to share the financial risk for the areas with the most homes at significant flood risk…

“The reason for that is that people who are at risk of flood, lots of those people being in Wales, a quarter of a million houses across the UK, those people are probably paying about a half of what the real risk of flood is,” he said…

“No country in the world has a free market for flood insurance with high levels of affordable cover without some form of government involvement.”

“We could have a complex system in which we could potentially see a charge of £20 or £30 across the board for everybody – whether affected by flood or not – with everybody doing their bit.

“But that could be viewed as being unfair on the poor.”

The problem with flood insurance is that everyone engaging in risky behavior by living in a floodplain will suffer a loss.  If a flood washes away every home they will have to rebuild every home.  Instead of everyone paying a little bit to pay for one or two lost homes everyone will have to pay a lot.  To cover the replacement value of their own home.  Because there is no way to spread the risk when everyone suffers a loss.

When your insurance premium is the value of the home your insurance is not insurance.  You’re just putting some money aside so you can buy your house again in another 10 years or so.  Or however often a floodplain floods.  Which is the risk people take by living in floodplains.  Or should be.  But governments step in and have the responsible living outside of floodplains subsidize the risky behavior of those living in floodplains.  By subsidizing the cost of their irresponsible behavior with taxpayer money.

Yes, it is heart-wrenching to see the devastation of a massive flood.  Like in New Jersey and New York following Hurricane Sandy.  And seeing those homeowners lose everything.  Especially those who did not renew their federally provided flood insurance (it is a federal requirement to buy flood insurance when buying a house in a floodplain.  But there is no federal requirement to renew that coverage once the initial term of that policy expires).  Because it was too costly.

Coastal areas have beautiful vistas.  Which is why people take risks and move into floodplains.  But if they do they should bear the financial costs.  Not those living responsibly.  With far less beautiful vistas.

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