This year’s summer flooding in the UK has raised new concerns about insurers’ ability to deal with these extreme risks

The extensive flooding that hit the UK this summer served as a double wake-up call: it first and foremost put the UK back at the centre of the climate change debate. But it also raised concerns about insurers’ ability to deal with a potentially long-term, high-risk situation. With Risk Management Solutions (RMS) predicting that insured losses from the flood events in June and July alone could reach £3.25bn ($7bn), the issue of flooding is very much on the agenda.

But Luca Albertini, managing director and head of European ABS/ILS origination and structuring at Swiss Re Capital Management and Advisory, speaking at Insuring Climate Change, pointed out that it should come as no surprise that the UK is vulnerable to floods. “The UK has suffered four larger loss events in the last 10 years,” he said, “and three of them have a return period exceeding 20 years. What we are seeing now is above average flood activity and this is in line with almost all research results which predict higher activity due to climate change.”

Fellow conference speaker Swenja Surminski, policy adviser on Climate Change for the Association of British Insurers, confirmed Albertini’s opinion earlier this year. “UK flood risk is nothing new,” she explained. “It isn’t something we’ve just discovered. It’s been on our agenda since 2000.”

Jonathan Spry, senior vice president, GC Securities, also speaking at the conference, described how the capital markets could provide solutions to UK flood risk. “Although it is undoubtable that the capital markets will play a role in securitising flood risk, there are factors which must be considered carefully,” he said. “For example, should one use simple solutions which have a high basis risk, or more highly complex solutions with a much lower basis risk?”

World first

“The highly innovative part of this project was the creation of a parametric index based on flood depths as measured after the occurrence of a significant flood event, at the strategically-selected reference locations across the UK

Luca Albertini, Swiss Re

Spry was involved in one of the only securitised UK flood risk transactions, emanating from Blue Wings Ltd. This Cayman Islands-based special purpose vehicle is sponsored by Allianz and intermediated by Swiss Re, and represents the first time a cat bond has covered flood risk and met the expectations of both the sponsors and investors.

Part of a $1bn programme, the first $150m bond was issued in April this year. The bond holds two risks - first, earthquake in Canada and the US excluding California, using a “modelled loss” trigger; and second, river flood in the UK using a second-generation parametric index trigger. It is this trigger that represents the real innovation behind the project.

While the loss caused by an earthquake in Canada or the US will be based on a modelled loss of a notional portfolio of exposures, the index for river flood was more or less created as a bespoke product for the bond. “The highly innovative part of this project was the creation of a parametric index based on flood depths,” said Albertini, “as measured after the occurrence of a significant flood event, at the strategically-selected reference locations across the UK.”

Around 58 reference locations were identified across the UK in locations outside areas which RMS considered to be at risk from storm surges. At each location, a pre-event reference point was taken. This could range from a gargoyle on a church turret to the window height on a house. After a flooding event, the flood watermark would be measured against the pre-event reference point to determine if the event triggered the bond.

“For river flood we have developed a robust index which has been welcomed by investors as it provides a transparent and objective mechanism,” explained Amer Ahmed, chief risk officer at Allianz Global Corporate & Specialty earlier this year. “It enables us to limit the basis risk without restricting our portfolio.”