The end of the government and insurance industry's Statement of Principles (SoP) agreement to provide insurance in high flood risk areas in June 2013 may prove positive for the UK insurance industry, according to Fitch Ratings. Although potentially problematic for as many as 200,000 UK property owners in flood-exposed regions, a return to a system where insurers can price appropriately for risk and where existing market distortions are removed would be beneficial for UK insurers' credit profiles.

The Association of British Insurers says the SoP will not be renewed because it believes it grossly distorts the insurance market. Under the SoP, the insurance industry agreed to provide flood cover to existing domestic property and small business customers at significant flood risk provided the government announced plans to reduce the risk to below a 1 in 75 chance of flooding within five years from July 2008. The insurance industry has been frustrated by the speed with which these improvements have been made and has expressed concern about £171m cuts made to the Environment Agency's budget for flood defences.

Fitch considers the most likely outcome to be a pooling of the risks, which may include a government subsidy. This approach to flood risk, and other catastrophe exposures has been taken by many other countries around the world and would ensure the availability and affordability of insurance for the minority of property owners whose properties are located in high flood risk areas.

Any government-backed scheme for flood protection would inevitably be complex and challenging to fund, the agency points out, and administrative costs could be burdensome. However, they view the alternative of a free insurance market and the implications this may have on the availability and cost of insurance in flood risk areas as even more challenging.

Fitch expects insurance losses due to floods to rise in future due to the increase in the frequency and severity of flood losses from climate change, the increase in property values and the propensity to build in flood plains. Flood losses cost the insurance industry about £3bn in 2007.

One in four homes in the UK is at risk from flooding, and the wettest April in the UK since records began and a forecast for a wet May to come have brought the importance of flood protection to the fore. Without some form of agreement there could be material declines in the value of properties that are either potentially uninsurable, or where premiums increase dramatically.

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