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Defra impact assessment shows Flood Re could breach EU law, newspaper claims

The Government's own assessment of a new cost-effective flood insurance scheme shows that it is poor value for money and could breach EU state aid rules, a report in the Daily Telegraph has claimed.29 Aug 2013

An impact assessment published alongside the proposals (52-page / 837KB PDF) also said that the proposed Flood Re scheme would be likely to "be classified by the Office for National Statistics as a tax", rather than an additional regulatory burden on businesses.

The Department for the Environment, Food and Rural Affairs (Defra) consulted on four possible options for a scheme to cap flood insurance premiums for properties in high-risk areas, in a process that concluded earlier this month. Two of these options, including the industry's preferred Flood Re scheme, would require state aid approval from the European Commission before they could be introduced, according to the impact assessment.

The Telegraph reported that this process can take between 18 and 24 months, and that the Commission could refuse to approve the Flood Re plans demand a redesign of the system.

The Association of British Insurers (ABI) entered into an agreement in principle with the Government to develop Flood Re, a new not-for-profit flood insurance scheme, at the end of June. Once established, Flood Re would provide certainty to householders by capping flood insurance premiums, based on the council tax band of the property. Claims made by people in homes at high risk of flooding would be funded through an industry-backed levy, which would be passed back to consumers at an estimated cost of £10.50 on annual premiums.

It is anticipated that the scheme will be set out in the Water Bill and that it would last for at least the next 20 years. The current industry Statement of Principles, under which insurers will continue to offer flood cover to existing customers where the risk is not "significant" or the Government has announced plans to reduce the property's flood risk within five years, will be extended until the Bill has passed through Parliament and Flood Re is set up. The ABI expects the new scheme to be in place by summer 2015.

The ABI's Statement of Principles was originally due to expire in July. The trade body had previously raised concerns that the current arrangements were "unsustainable" and had distorted competition in the insurance market as there were no incentives for new insurers to offer flood cover, while customers were unable to switch suppliers without losing the benefit of the agreement.

Defra's consultation set out four options for the future of flood insurance, priced against a 'base line' non-intervention approach. These were to encourage within-industry measures, to operate in conjunction with a small 'community resilience fund for local authorities; to offer direct subsidies, funded by an industry levy, to high-risk properties; to create a regulatory Flood Insurance Obligation, guaranteeing the availability of affordable flood insurance; and the proposed Flood Re scheme.

The impact assessment did not suggest a preferred policy approach, stating that this was "currently being determined in conjunction with Ministers and alongside ongoing discussion with ABI and the results of wider consultation". It added that there were "inherent uncertainties" in much of the analysis.

"[Flood Re] can offer benefit in terms of equity and market participation by households (subject to specific design), but economic performance appears very variable," the assessment said. "The key issue is the potential economic cost of any net liability for a separate flood insurance pool, with the expected costs of managing this liability highly likely to be in excess of the benefits delivered to high risk households."

"However, Flood Re may offer two things not achieved by [the other options] – namely, better confidence in the actual cost of flood insurance to consumers in the medium term (which would be more firmly within Government's control than under a subsidy or obligation), plus industry support in managing a smooth transition to Flood Re pricing in the immediate term," it said.