Pricing flood risks

According to the British flood insurance claims database (the biggest of its kind in the world) the average claim for a one metre summer flood in Britain is £22,000 for buildings and £13,000 for contents. A winter flood of the same severity can cost twice as much because of longer drying out times.

If the claims cost is £35,000 for a single house in an area where the probability of flood is 1% (the '100-year event'), a risk premium of £350 per year is needed just for the flood risk element.

Climate change projections indicate that by 2020, the risk premium will have to be increased to £583 assuming no inflation or change in contents mix.

Insurers used to calculate premiums using historic claims experience and adjusting it for inflation. Now it is not so easy because with climate change the past is no longer a sufficiently reliable guide to the future. For many parts of the country, cheap insurance will be just a memory, and for some, getting insurance at any price will be a problem.

There are three major factors to be considered: exposure; vulnerability; and hazard.

Exposure: insurers are now mapping flood risk areas in much more detail even down to individual address level so that the premium reflects the risk. This means that residents in safe areas are no longer expected to subsidise those who live in flood plains.

As pressure to find land for building grows, an increasing number of houses in England are being built in flood risk areas. Some 56% of English local authorities have knowingly allowed developments in flood hazard areas.

Insurers could make a difference by talking directly with local planners. For more than 10 years, this has been happening in Scotland where planning rules require consultation at a local level with the insurance industry. Local authorities representing 98% of the population in Scotland have established Flood Liaison and Advice Groups (FLAGs) with insurance representation. As a result the insurance template has been incorporated in the planning strategies of all major local authorities.

Vulnerability: in England there is a great deal of pressure to find land for building and insurers have to accept that an increasing number of new buildings will be located in flood hazard areas despite the risk.

There can be sound economic or logistical reasons for this, for example the Thames Gateway or the Olympic Village developments. But vulnerability is increasing, with more old people, more dependence on electronics, and more use of chipboard in kitchen units and floors. Insurers should be taking a much firmer approach to building regulations.

Hazard: Current climate change predictions for England show that although there will be warmer weather with more droughts, there will also be more rainfall concentrated in extreme events. In addition, rising sea levels and more severe storm surges will lead to more coastal flooding and many coastal areas will have to be abandoned to the sea.

So will insurers be out of their depth? The answer is almost certainly 'no'. Leading insurers are taking advantage of new technology, using the flood claims database, and collecting data to quantify the exposure and vulnerability.

If the risk becomes too severe, insurers can simply withdraw cover, which in turn may force the authorities to take the risks more seriously.

Insurers say they do not want to cancel policies, they would rather price them to reflect the risk and are increasingly doing so. But pricing alone is not the answer. Insurers need to be more proactive in seeking out information and managing the risk before it becomes much bigger.

Natural disasters have also been increasing. The most notable in recent times being the 2004 Asian tsunami, and the 2005 hurricanes in the Gulf of Mexico. These have highlighted the risks to coastal cities from the sea.

Here in the UK, the jury is still out on whether an increase in storms can be expected due to climate change. However there are persuasive arguments that storm tracks may change. According to the Met Office Hadley Centre the number of severe storms crossing England has doubled in the past 50 years.

This is bad news for insurers: traditionally, storms have tended to track over the north of Scotland, where buildings are constructed to very resilient standards. If these storms move south where buildings are much less resilient and more densely concentrated, then losses could be severe as was demonstrated in the storms of October 1997 (1 million claims) and January and February 1990 (3 million claims).

So will insurers be blown away? The answer is almost certainly "no". Insurers are buying more reinsurance to spread the risk globally. The danger is that a "catastrophe clash" could hit markets in different continents at the same time.

Insurers could certainly become much more proactive in encouraging society to adapt to climate change by using more resilient construction methods.

' Professor David Crichton is a visiting professor at the Benfield Hazard Research Centre, University College, London

The winner of the 'Name that building' competition was James Stiff, of Gerling. He will receive a copy of Professor Crichton's new book, "Adapting Buildings and Cities for Climate Change". The building was the Hadley Centre at the Met Office in Exeter