Sea change in flood risk insurance - Flood Re

Will you be adequately covered by flood risk insurance? – maybe. Under the old model the government paid to build flood defences while insisting that insurers cover most properties in flood risk areas. Now a new scheme known as Flood Re is being introduced. All householders taking out insurance will pay a £10.50 levy to Flood Re, the new not-for-profit fund to subsidise premiums for 500 000 homes in flood prone areas.

But there are constraints. Houses in the top council tax band and business will not be allowed to join the scheme. Houses with a risk higher than 1-in-75 are excluded and all new houses built after 2009 will not be covered. The assumption being that new houses must have adequate flood defences before they are built but in 2011 28 000 were planned to be built on flood plains alone.

There are two big problems. Firstly while spending on flood defence increased from the 1970’s to 2010 it is now decreasing. Secondly the risk of flooding is increasing due to:

• ·      Climate change would could lead to rising sea levels and changes in rainfall
• ·      Ageing drainage and flood defence infrastructure
• ·      More buildings in flood-prone areas  
• ·      More paving, which increases the volume of water running off 

The concern is that the Flood Re scheme will run out of money to cover the insurance bill as the risk increases and flood defence spending lags behind. The Environment Agency estimates that flood damage costs £1.1 billion a year of which only part will be covered by Flood Re (its annual income is set at £180m pa). Perhaps householders in flood risk areas should put sandbags and wellingtons on their Christmas list.

Flood risk averted

Its remarkable to realise that last weeks storm surge down the North Sea was 2ft higher than the devastating floods that occurred in 1953. The fact that only a few people were affected and that there was no major loss of life is a real tribute to the progress made with flood defences over the last 50 years. 

Unlike 1953 when many people had no warning this time there was extensive news coverage for several days in advance and the excellent warnings issued by the Environment Agency. But warnings don't stop flooding, the real key is of course having adequate flood defences. Here the fact that the defences coped with levels higher than those of 1953 is a testament to their design. 

But what of the future? The predictions of the impact of climate change on sea water levels are uncertain although everyone is convinced they will increase. Its also clear the weather is getting more variable and extreme. With a quarter of the Anglian Water region being below sea level the only option is to continue strengthening the sea defences. The temptation for politicians is to put off the investment. Last weeks flood shows there is no room for complacency.

Water companies plan to hold prices for 2015-2020

Photo courtesy of Thames Water shows Lee Tunnel boring machinee

All the water companies with the exception of Thames Water are planning to either freeze or reduce prices in real terms in their business plans released today (2 December). The exception is Thames Water who are proposing a 11% price hike (£40 increase) to cover investment in the Thames Tideway Tunnel. 

The draft business plans submitted by the water companies to Ofwat cover the next regulatory period 2015 to 2020.

The average water bill is currently about £388. Southern Water, for example is proposing to cut bills by £6 over the next five years. But customers are unlikely to notice the reduction as over the same period bills will increase by £78 to cover anticipated inflation. This is the crutch of the problem for water companies, how to justify this increase at a time when most customer's income are not increasing by the rate of inflation.

Partly its about clear communication. Here the water companies have a lot to learn. Southern Water in justifying the increase says: "1% of your bill will go towards ensuring your bill remains affordable. While Monty Python fans would be delighted by this logic,  most customers will fail to understand how increasing bills by 1% makes them more affordable?

The summary is no clearer. It says: "under this plan, average bills will rise by less than (0.6 per cent) the rate of inflation from 2015 to 2020".  Why not simply say average bills will decrease by £6 from £438 to £432 over the next five year period before inflation is added. 

When its appreciated, for example, that the average age of the water mains is over 100 years then it starts to become more understandable that the current rate of water mains renewal is inadequate and hence that investment (and consequently bills) will need to increase.

With a backdrop of increasing customer mistrust of water companies its absolutely vital for all those who care about the industry that the reasons why investment must continue are clearly explained.

Political tide turns for water companies

Photo: New boiler house under construction at Thames Water's Crossness STW
This week will see the water companies announcing their draft business plans for AMP6 (the next regulatory period from 2015 to 2020). It comes at a time of an increasingly hostile political environment. The recent focus on energy bills is spilling over into the water industry with Ed Millband signalling that the water companies will be next in the dock as part of Labour's campaign to tackle the cost of living crisis. 

Thames Water recently had its attempt to increase charges for eight million households by £29 each rejected by Ofwat. Thames Water wanted to increase charges to pay for spiralling bad debts from bill dodgers costing it about £88m a year. Instead the plan has spectacularly backfired after Ofwat threatened to launch a counter-investigation into Thames profits.

The regulator is known to believe that water companies in general have been making far greater profits than envisaged because charges rise above the rate of inflation during a time of record low costs of borrowing. 

Sonia Brown, Ofwat's chief regulation officer, said that it would carefully scrutinise all the proposals covering 2015 to 2020. "If you take an average bill, we think there can be big savings because the cost of debt and equity is much lower. There is a big opportunity for these bills to go down," Brown said.

Against this backdrop its clear that water companies will have to become much more adroit at explaining why investment needs to increase.

New CEO at Severn Trent signals change

Photo: Liv Garfield leaves BT to join Severn Trent 
Severn Trent has appointed Liv Garfield to its new Chief Executive. Her appointment boosts the number of female FTSE100 bosses to four. She will also be one of the youngest FTSE chief executives. 

Her background is certainly not in water, she read languages at Cambridge before starting her career by joining Accenture as a management consultant. Ms Garfield joined BT in 2003 and has been credited with delivery of the £2.5bn roll-out of fibre broadband which was running 18 months ahead of schedule. She was named in September as one of the top 10 young high flyers in Fortune magasine's annual 40 under 40 list making her the highest ranking Brit in the table.

In the view of the blog this is exactly the sort of imaginative appointment the water industry needs. Its absolutely vital the industry attacks bright, young graduates and especially female staff. Currently the water industry lags far behind many sectors in the number of female staff employed especially in senior positions. Admittedly its not just the water sector that struggles to attract the best graduates. Engineering generally has a huge mountain to climb before it becomes the first choice of graduates male and female. 

The water sector is facing huge challenges with climate change and the conflict between the desire of customers to see bills reduce and the need to invest heavily to renew ageing assets. Its only by getting some fresh thinking and the very best joining the industry that a way will be found to resolve these dilemmas.  

What is holding back innovation in the water sector?

The industry is currently driven by environmental legislation. But these same regulations can restrict innovation when compliance is needed 24/7. These tighter environmental standards get even tighter as the mitigate down the supply chain to sub-contractors who understandable want to impose a safety margin to avoid liquidated damages for performance failure.

There is innovation happening in unexpected places. Fat from restaurants and build-ups in drains is set to power Britain’s largest sewage works at Beckton. Certainly over the next 10 years the rate of change will be unprecedented. But utility management is about evolution not revolution due to the need to avoid taking massive risks.

Customers certainly do not want risk. Many prefer the predictability of a fixed water bill, especially having been stung with unexpected changes in electricity bills. Who wants a different colour of water out of the tap? 

How are long term targets such as CO2 reduction to be achieved if the rules are changed. Money is spent on carbon reduction projects then the rules affecting their financing get changed. It is not an incentive to innovate instead it pushes unrealistically short term paybacks. 

Fair return in the water industry

What is a fair return for investors in the water industry? The recent announcement that water bills are going up again at above inflation rates for many water companies, brings into stark relief what is a reasonable rate of return for investors?

This is no doubt that massive investment will continue to be needed in the water industry and that if water companies are to continue to invest they need to be rewarded. But is the balance right between investors and customers? Perhaps the best way to judge this is whether the water companies are having difficulty in raising funds or attracting investors.

The water industry offers some unique benefits, it is inherently an extremely low risk business with no chance of losing its customers. Each water company is still a monopoly. The probability of customers in say the London area ceasing to want water is zero. In fact it is quite the opposite, demand is steadily growing driven by population growth and changing lifestyles. They are not many businesses that have guaranteed sales. 

The water industry is very predictable. With the Ofwat regulatory regime prices and incomes are fixed for 5 year periods totally independent of what might be happening in the wider economy. Secondly the industry is driven by legislation and this is visible many years ahead. So water offers a very low risk investment with predictable and steady income. Its not surprising that there is such demand from pension funds and infrastructure investment companies to invest in the sector.

Every time a water company ownership changes the previous owners walk away with a windfall, just look at Thames and the money RWE made from their investment. With the recent divestment by Veolia Central, there were a large number of potential bidders, This does suggest that returns on investment may still be too high.