Flood Re: It's here and it looks good

The long wait for a deal between the insurance industry and the government on a viable flood insurance scheme is over. My initial reaction is that it has been worth the wait.

The multi-faceted deal ticks alot of boxes and should steady the nerves of those who feared we were lurching towards a free market with tens of thousands of homeowners cast adrift without insurance.

Flood defence spending
Let's start where we left off yesterday with flood defence spending. I didn't feel too encouraged by the initial announcements on revenue spending yesterday, despite the Chancellor's rhetoric. This money largely supports existing schemes and prevention initiatives and has effectively been frozen at this year's level of £226m, just over 5% below the level when the Coalition government was formed in 2010.

The focus therefore switched to the capital expenditure which was announced alongside the spending plans for infrastructure projects this morning. For once, my cynicism was misplaced.

At £370m a year, inflation proofed and guaranteed until 2020-21, this is at the top end of expectations. It exceeds the £344m being spent this year and is £16m above the previous high water mark of 2010-11. However, five years ago the total spending on flood defences (revenue and capital spending combined) was £629m compared to the combined total of £596m we are looking at for next year: this is the only serious negative comparison.

The figure has delighted the Association of British Insurers, not just because it represents a significant boost to the flood defence programme but also because it comes with a five year inflation-proofed guarantee, taking it beyond the life of the next government. By all accounts the ABI team in the negotiations argued long and hard for spending at this level to be underpinned by a long term commitment, making it clear to Oliver Letwin, who led on the government side, that it was a deal breaker.

Hopefully, this will allow for a better planned and more efficiently delivered flood defence building programme between now and 2021.

The Flood Re deal
There is plenty of information already on how Flood Re will operate with a very good FAQ on the ABI website so I won't repeat all of that detail here.

Two features immediately strike me as clever.

The first is the use of Council Tax bands to set the premium levels which will make it easy for households in high risk flood zones to see what they will be paying – and the premiums (£210-£540 a year) are not excessive. Not published so far because some details have still to be worked out is a similar scheme for controlling excesses which will be capped in the range of £250 to £500, taking away the legitimate complaints starting to emerge about the high excesses being charged by some insurers.

The second clever feature is the cross-subsidy of £10.50 per policy, which is also described as a levy. This is very neat because it raises the same £180m that the cross-subsidy currently built into household insurance policies does so won't actually affect existing premiums. By fixing this initial levy at over £10 the government and the ABI have made life easier for themselves should they need to push the levy/cross-subsidy up in the future. A figure below £10 would have always raised the tricky issue of breaching a psychological (and thus political) barrier of £10.

Loose ends
There are, inevitably, a few loose ends in the outline agreement that was announcement earlier today.

The future of cover for small business with a turnover under £1m seems uncertain. Currently, they are included in the Statement of Principles but it looks as if many will find themselves outside the Flood Re net. The most likely definition of who is included and who is excluded will be whether they pay Council Tax or Business Rates, a logical way of dealing with the problem given the use of Council Tax banding as the key premium rating factor.

It also isn't clear where the SMEs will stand with the roll-over of the SoP until next summer when the legislation is expected to be passed.

The exclusion of homes in the highest Council Tax band (H) which is for all homes valued at over £320,000 in England and Wales at 1991 prices (£212,000 in Scotland) seems abit sweeping and could become a sticking point for some MPs when the Water Bill goes through Parliament.

More understandable as an exclusion is homes built after 1 January 2009 for the simple reason that nobody, just nobody should have been building on a flood plain or in other high risk areas since then. If the floods at the turn of the century weren't enough to convince builders and local authorities of the folly of building on flood plains then surely the 2007 floods must have convinced all except those that didn't want to be convinced. If people have bought those homes their argument is with the developers and the planning authorities.

Of course, there is also the small matter of having to get European Union approval for the scheme because elements of it will be considered as state aid. With large parts of Europe having experienced severe flooding in recent years, the EU is more likely to welcome this as an option that might work in other countries struggling to make affordable flood insurance available than see it as something they should block.

If it doesn't happen?
If Flood Re can't be made to work, especially if it stalls through any hesitation on the part of the insurance industry, then the government has made it clear it will resort to what one insider today called "the nuclear option" – compulsion. Quite simply, every insurer operating in the household insurance market would be obliged to offer flood cover on terms set out by the government. Unthinkable? I hope so.

Overall, this has been a good day for the reputation of the British insurance industry and for the often maligned Department of Environment, Food and Rural Affairs.