Nicola Garbarino, Benjamin Jane, and Jonathan Lee
5.2 million properties in England are at risk of flooding. To ensure the availability and affordability of flood insurance for households in flood-prone areas, the UK government introduced an innovative reinsurance scheme, Flood Re, in April 2016. It provides insurers with the option to pass the flood risk component of their policies on to the reinsurer at a lower fixed rate in accordance with For the property council tax category. In our recently published Staff Working Paper we use an accurate dataset for all property transactions and flood events in England. We appreciate the impact of Flood Re on property values. We also explore whether the effects of Flood Re are heterogeneous across different subpopulations in England.
Flood Re reduces insurance premiums for households in flood-risk areas by more than half for four out of five properties with previous flood claims. This should increase the values of properties prone to flooding. However, in theory, the magnitude of this property price effect depends on the expected reduction in future insurance premiums caused by Flood Re as well as the discount rate for future insurance premiums. Furthermore, the impact of Flood Re may vary by region and demographic groups due to differences in flood risk and home ownership.
An Empirical Approach to Determine the Impact of House Price from Flood Re
In our research, we examine property in England. We use the Repeat Selling Approach to screen only 1.5 million properties built before 2002 that have sold multiple times. Specifically, we reverse the change in real estate prices when they are flooded. In our regression, we interact with this flood exposure with a binary variable that captures the time period when Flood Re was running. The nature of this research design allows us to calculate unobservable property characteristics that do not change over time, by examining the effect of floods on property prices before and after the advent of Flood Re. To measure the heterogeneous effects of policy, we then estimate our regression in different subsamples. To this end, we segment our data by property values and various regional characteristics, such as their income level, obtained from the National Statistics Office.
Average impact of Flood Re on real estate prices
Chart 1 shows the impact of Flood Re on flooded property prices. We first performed regression on the full sample of properties in England. We find that flood events reduce property values by more than 1.5% relative to their first transition prior to the introduction of Flood Re. This negative effect is completely mitigated after the introduction of Flood Re.
Graph 1: The impact of Flood Re on real estate prices
For an average property the introduction of Flood Re increases the relative price of the property as a result of the flood by £4,083. Then we do the math on the back of the envelope out of the 5.2 million properties at risk of flooding in England. It points out that supporting Flood Re increases the total value of flooded property by £212.3m a year, assuming that only 1% of vulnerable properties are flooded annually. The overall impact of Flood Re on property values would double to £424.6m if the probability of flood risk increased to 2%.
Our results indicate that Flood Re also increases the volume of real estate transactions in vulnerable areas. Graph 2 shows the effects of Flood Re on flooded real estate transaction volumes. Our results indicate that a property that was flooded had a 3.6% decrease in the annual probability of transactions prior to the start of the Flood Re program. Flood Re more than offsets this negative impact on transaction probability and increases flooded real estate transactions.
Figure 2: The impact of Flood Re on market liquidity
Regional heterogeneity in real estate price response
We also explore the heterogeneous effects of Flood Re in different regions across England. To this end, we create subsamples by using the mean values of the principal variables to halve the original sample. Flood Re’s effect is strongest in metropolitan areas with higher incomes and older populations as well as areas with more rental property. While it would be interesting to identify the channels that lead to the parasympathetic effects, our study leaves this question for future research due to a lack of precise data.
Conclusion and discussion
Our results illustrate two major implications. First, we document the effects of heterogeneous Flood Re. Interestingly, our results indicate that Flood Re has a weak effect in low-income areas but a stronger effect in high-income areas. These results can be considered as evidence hinting at the distributional consequences of this reinsurance scheme in terms of wealth among homeowners in England.
Second, the results are relevant to the transmission risks of public policy interventions. The Flood Re program is expected to be phased out in 2039. Thus the flood risk component of property insurance may be fully priced into premiums by then. Thus, the value of properties subject to flood risk may undergo a sudden adjustment, reflecting the increase in current and future premiums. However, the size of the impact we estimate does not seem large enough to disrupt the real estate and financial markets, but this could change if perceptions of flood risk change in the coming decades.
Nicola Garbarino works at the Ludwig-Maximilians-University of Munich and the Ifo Institute, Benjamin Jain works in the Bank’s Strategy and Policy department, and Jonathan Lee works at the University of Glasgow.
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