Nicola Garbarino, Benjamin Guin and Jonathan Lee
5.2 million properties in England are at risk of flooding. To ensure the availability and affordability of flood insurance for homes in flood prone areas, the UK government introduced an innovative reinsurance scheme, Flood Re, in April 2016. It gives insurers the option to transfer the element of flood risk from their policies to the reinsurer at a lower fixed price according to the property council’s tax band. in a Recently Released Staff Working Paper, we use a granular data set of all property transactions and flood events in England. We estimate the effect 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 homes in flood risk areas in more than half for four out of five properties with prior flood claims. This should increase the values of flood prone properties. In theory, however, 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 on future insurance premiums. Additionally, the Flood Re effect can vary by area and demographic groups due to differences in flood risk and home ownership.
Empirical approach to identify the house price effect of Flood Re
In our research, we examine properties in England. We use a ‘repeat sales approach’ that examines only the 1.5 million properties built before 2002 and sold multiple times. Specifically, we regress the property’s price change on its exposure to flooding. In our regression, we interacted this flood exposure with a dummy variable that captures the time period in which Flood Re was operating. The nature of this research design allows us to account for unobservable, time-invariant property characteristics. , by examining the effect of flooding on property prices both before and after Flood Re hit. To measure the heterogeneous effects of the policy, we then estimated our regression on different subsamples. To do this, we split our data by property values and different regional characteristics, such as their income level, obtained from the Office for National Statistics.
Average Impact of Flood Re on Property Prices
Chart 1 illustrates the effect of Flood Re on flooded property prices. We first run our regression on the full sample of properties in England. We found that floods reduce property values by more than 1.5% relative to their first transition before the introduction of Flood Re. This negative effect is fully mitigated after the introduction of Flood Re.
Graph 1: Effect of Flood Re on property prices
For the average property, the introduction of Flood Re increases the relative price of properties as a result of flooding by £4,083. We then carried out a detailed calculation among the 5.2 million properties that are at risk of flooding in England. It suggests that the Flood Re grant increases the total value of flooded properties by £212.3 million per year, assuming only 1% of properties at risk flood annually. The total effect of Flood Re on property values would double to £424.6 million if the probability of flood risk increases further to 2%.
Our results suggest that Flood Re also increases property transaction volumes in risk areas. Chart 2 depicts the effects of Flood Re on transaction volumes for flooded properties. Our results suggest that a flooded property has a 3.6% reduction in the annual probability of transacting before Flood Re was introduced. Flood Re more than offsets this negative effect on transaction probability and increases the transaction of flooded properties .
Graph 2: Effect of Flood Re on market liquidity
Regional heterogeneity in the response of house prices
We also explore the heterogeneous effects of Flood Re in different areas of England. To that end, we created subsamples using median values of key variables to divide the original sample in half. The Flood Re effect is strongest in urban areas with higher incomes and an older population, as well as in areas with more rental properties. While it would be interesting to identify the channels that lead to the heterogeneous effects, our study leaves this question for future research due to a lack of more granular data.
Conclusion and discussion
Our results illustrate two key implications. First, we document the heterogeneous effects of Flood Re. Interestingly, our results suggest that Flood Re has a weak impact in low-income areas but a stronger impact in higher-income areas. These results can be seen as evidence pointing to the distributional consequences of this reinsurance scheme in terms of wealth among homeowners in England.
Second, the results are relevant to the transition risk of public policy interventions. Flood Re is expected to be phased out in 2039. Therefore, the flood risk component of property insurance may be fully priced into premiums by that time. Consequently, the value of properties at risk of flooding may experience a sudden adjustment, reflecting the increase in current and future premiums. However, the magnitude of the effect that we estimate does not seem large enough to disrupt housing and financial markets, but this may change if the perception of flood risk changes in the coming decades.
Nicola Garbarino works at the Ludwig Maximilian University of Munich and the Ifo Institute, Benjamin Guin works in the Bank’s Strategy and Policy Approach Division and Jonathan Lee works at the University of Glasgow.
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