Sep 27, 2012 3 min read

Flood, fairness and risk assessment – pt3

In the third of this series of posts about ethical issues associated with the future provision of flood insurance in the UK, I’m going to look at the role that risk reduction is taking.

It’s a feature of insurance that policyholders who take measures to reduce the risk their policy presents to the insurance pool receive a reduced premium in return. The policyholder who takes such measures should end up better off than a neighbour who takes no such measures – insurers refer to this as part of the risk’s ‘moral hazard’.

This arrangement replies on both parties to the insurance contract having a shared understanding of the particular risk in question and of the risk reduction measures that are available. Unfortunately, this level of transparency doesn’t appear to be a feature of how insurers are engaging with individual policyholders in areas of significant flood risk. Renewals fail to explain the reason for the policy’s increased premium, let alone advise on how that increase could be contained by risk reduction measures.

This lack of transparency has a dangerous knock-on affect into the availability of cover for flood. I’ve posted before about the dangers that policyholders, unaware of why their household premiums are shooting up, seek less expensive cover elsewhere and find themselves inadvertently without flood cover through both the assumptions built into insurance price comparison websites and the way in which those assumptions are then treated by individual insurers.

So on the one hand, insurers are saying that cover will be available for those in areas of significant flood risk, but on the other hand, seem to be failing to fulfill what many would consider as reasonable expectations around transparency in renewal and new business processes.

Let’s assume however that this transparency issue is resolved. What then should the informed policyholder do about reducing the risk their policy presents? As outlined about, turning to their insurer for advice doesn’t seem to be an option. According to the researchers from the University of Dundee, insurers put little to no value on the flood risk reduction measures that an individual policyholder might implement. This is a pity, for it will impact on the moral attitude that policyholders take towards their cover: in other words, why should we bother to contain our loss if insurers appear not to be bothered either.

Insurers view the risk reductions for flood that individual policyholders might take as mere palliative measures that dim into insignificance when compared with structural defences installed at river level. The reasons for this preference are revealing. Insurers told the researchers from the University of Dundee that they prefer structural defences because that is the type of risk reduction measures their systems are set up to receive data on for analysis and monitoring. They view individual and community based measures as insignificant because they find their effectiveness too difficult to measure.

This viewpoint presents a number of dangers for insurers:

The first danger is from the undermining of moral attitude outlined earlier: if the policyholder thinks their insurer is not interested in what they can do to reduce the risk, then lo and behold, the policyholder will follow suit and take no interest either.

The second danger is from the apparent contradiction inherent in insurers being able, at the micro level, to judge a policy’s risk but at that same micro level, unable to judge the risk reduction measures taken by the policyholder. Meanwhile, insurers are willing to view risk reduction measures at the macro level as effective, but that same macro level as inappropriate for pricing the risks themselves.

The third danger is that it risks reinforcing the public’s sense of unfairness in how risks are being assessed. While insurance is based upon differentiating between risks, through the use of categories that act as proxies for the actual risks being considered, the use of incomplete or inadequate categories to fully assess a risk starts a drift from differentiation towards discrimination. If insurers’ focus on geospatial data for assessing flood risk begins to look more about convenience and less about fairness, then the ethics of flood underwriting will become open to challenge.

The fourth danger is that over reliance on this approach may be putting too many eggs in one basket.There is evidence from Scotland (set out in this CII Thinkpiece) that sustainable flood management practices, using a variety of regulatory and community based flood defence initiatives, is proving more effective in reducing the impact of flood.

I’ll round up this series of posts on flood insurance in a final post early next week.

Duncan Minty
Duncan Minty
Duncan has been researching and writing about ethics in insurance for over 20 years. As a Chartered Insurance Practitioner, he combines market knowledge with a strong and independent radar on ethics.
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