The combination of tumbling house prices and the squeeze on credit has created a raft of problems for insurers. Katie Puckett explains.

When Bradford & Bingley joined Northern Rock in the doldrums earlier this month, it drove home the fact that the British housing boom is over. Between them the two banks had spearheaded the growth of buy-to-let and cheap property-plus mortgages respectively, contributing to soaring house prices – and a fluid, and lucrative market in household products for insurers. Now the insurance industry must deal with the knock-on effects of the collapse.

One inevitable consequence of a downturn in the economy is a rise in fraudulent claims across the residential market, particularly in easy-to-fake areas like accidental damage or arson. Insurers say they’ve already noticed ‘ ‘ a rise in this kind of claim coming through, and fear the impact on their already stretched accounts. “Underwriters are making provision for significant fraudulent claims,” says Karen Brown, director at broker Lockton. “When the economy falters, some individuals become overstretched and find they can’t make their payments, which leads them to act in ways that are not entirely honest. Some people steal from their clients, others commit fraudulent acts, and this can rebound on the employer or their professional adviser who fails to spot the fraud, leaving them open to PI claims.”

Recession also uncovers fraud that went on before. Brown’s colleague Steve Holland, executive director at Lockton, predicts the downturn will shine a light into shadowy corners of mortgage fraud that have lain undiscovered until now. “We are seeing an increase in mortgage fraud, ranging from application fraud where people say they have a higher salary than they do, or for buy-to-let, where they declare a higher rental income than they’re getting.”

There’s also valuation fraud where a surveyor and a solicitor conspire to defraud a lender, and the more complex and ingenious, split-title fraud. This is where a property has a large piece of ground attached, which is split away from the property legally and borrowed against. Holland adds: “They get a mortgage on what the lender thinks is a property, but it’s nothing more than a backyard.”

Solicitors and surveyors will see rises in their professional indemnity (PI) premiums as lenders and investors turn to their professional advisers for recompense, and insurers take evasive action. Mortgage brokers will also struggle. “Brokers have seen increases in their PI premiums, and in some cases they’re unable to get cover at all,” says Holland.

Insurers may find themselves caught in an uncomfortable pincer movement between higher claims from the kind of extreme weather conditions we saw last summer and defaulters calling on mortgage protection policies at one end, and more competition for new business on the other.

“When people are scrimping and saving they might be tempted to cut back on insurance. But in times of economic uncertainty you’re even less able to cope with the financial side.

For a start, while the size of the potential market for household and buildings insurance will remain the same, homeowners struggling to pay their mortgages might choose not to spend any of their precious disposable income on insurance. Ian Clark, insurance partner at Deloitte, says: “As and when recession hits there are questions around whether people still get buildings insurance and whether contents insurance is a discretionary spend, and volume goes down sharply.”

Philip Bird, underwriting director of non-motor and SME at Groupama, believes the market will certainly stagnate. “There’ll be less movement in the market because people aren’t moving house, so the flow of new business will dry up. There’ll be a small downward effect on rates because people want to keep renewals. But at the same time, some upward effect because of results last year. That’s two contrasting forces in my mind.”

The ABI believes that more than ever, insurers will have to convince the public that cover isn’t a luxury item but a necessary safeguard. “When people are scrimping and saving they might be tempted to cut back on insurance. But in times of economic uncertainty, should the worst happen, you’re even less able to cope with the financial side.” He points out that one in four households still doesn’t have contents insurance. The ABI is trying to rekindle interest in a scheme to encourage take-up of insurance among people on low incomes, and is in talks with local authorities about offering insurance bundled in with rent for tenants of councils and housing associations.

Insurers will no doubt be facing pay-outs on mortgage protection policies too, as interest ‘ ‘ rates rise and fixed rate deals come to an end – it is estimated that 1.5 million householders will find themselves on the wrong end of their lender’s standard variable rate this year. “There will certainly be more claims there if recession starts to take hold,” says Bird. Again, there’s a question over whether with greater risk of unemployment people will be more attracted to the security blanket of insurance or whether they simply won’t be able to afford it. Either way, Bird believes “premiums will definitely go up”.

There’s likely to be worse news for people living in those flood prone areas this summer though, and not least because they fear a repeat of the torrential rains that drowned swathes of the Midlands and the North and caused more than £3bn worth of damage. According to the ABI, two million homes, a tenth of the UK total, are at risk from coastal or inland flooding. It predicts that, without a change in government policy, climate change could increase the number of properties at risk to 3.5 million.

The ABI is reviewing its agreement with the government to provide cover in flood prone areas, and with government action on flood prevention still falling short, those homeowners may be left up a creek without a paddle. Bill Gloyn, chairman of real estate at Aon and president of the City Property Association, is concerned that in the worst areas, homeowners could be left with no insurance at all. “If flood insurance stops, property owners could find themselves in breach of their mortgage contracts. They have an obligation to arrange insurance. If they can’t, what’s going to be the outcome of that? There could be a severe risk if the bank says, ‘you’re not insuring, give us our money back’. The knock-on effects could be even worse, with mortgagees in default and repossessions. There’s a massive potential impact,” Gloyn says.

“People can’t afford to buy or choose not to, so the big tenant referencing businesses are seeing significant increases in volume.

The revised statement isn’t due out until later in the summer, after Sir Michael Pitt’s report on the lessons to be learned from last year’s deluge. But as Gloyn says: “I can’t see it’s going to result in cheaper premiums and wider cover.”

As for the buy-to-let market itself, the forecast is more mixed. Biba technical services manager Steve Foulsham suspects the boom in buy-to-let insurance products may be at an end: “The market has grown over the past few years, with lots of people with spare cash buying second properties and renting them out to pay the mortgage. I would suspect that because mortgages are a bit harder to come by now, that part of the market will begin to dry up.”

But despite the collapse of the market for new buy-to-let mortgages, the rental market could still be a promising hunting ground for insurers offering products for landlords or contents insurance aimed at tenants. Deloitte’s Clark says: “People can’t afford to buy or choose not to buy, so the big tenant referencing businesses like Homelet and Letsure are seeing significant increases in volume. There’s also the level of inward migration from, for example, the Polish community. They’re not going to be buying, so that’s a straight influx into the lettings market.”

Specialist area

Buy-to-let is a much more complex product than traditional household policies and treated as a specialist area by insurers and brokers. There is a Biba scheme for property investors, brokered by EIS Solutions – formerly part of Erinaceous – and underwritten by Groupama. Matthew Wiles, EIS’ customer relationship manager believes the market will continue to grow. He says: “House prices are still too high and first-time buyers still can’t get mortgages, so a lot of people are still renting and they will do so for another two or three years. The market has grown massively over the past few years. There are lots of people who sold property a few months ago, the clever ones are sitting on a massive investment fund to invest again if house prices are dropping.”

Landlords not only need insurance for their buildings but for a range of other hazards including malicious damage by tenants and help with legal costs should things go wrong and they need to carry out evictions. Many small investors are unaware that their household policies won’t cover lettings because they have restrictions on tenants living in a property. Some of the supposedly tailored products don’t cover malicious damage caused by tenants or loss of rental income. EIS is now looking into a policy to protect buy-to-let owners against the tax implications of their investments, aimed at the smaller end of the market.

All of which indicates that it’s not only going to be homeowners praying that the market recovers quickly. But insurers would do well to remember that, like the property market in a downturn, there is money to be made if you look in the right places. IT