High and dry? Flooding and uninsured risks

High and dry? Flooding and uninsured risks


Author: James Needham

The Statement of Principles on the Provision of Flood Insurance was last renewed by the Government and the Association of British Insurers (ABI) in July 2008.

Since then, it has underpinned the availability of flood insurance to households and small businesses in the UK.

The Statement lasts until 1 July 2013. It was envisaged that by that date, the insurance industry would have developed a scheme to make flood insurance widely available without the need for Government intervention.

With 1 July looming, no workable solution has yet be found. Discussions continue between the Government and the ABI, but there is no intention to renew the Statement.

There is growing concern - aggravated by the regularity of major flooding in various parts of the UK - that following the expiry of the Statement, flood insurance will be withdrawn or made available only on materially increased premiums in those parts of the country at significant risk.

Dealing with uninsured risks is not new for the UK commercial property market. The threat of IRA terrorism in the 1990s led to terrorism cover being withdrawn for many commercial buildings.

The perceived reduction in terrorist threat and the advent of the mutual insurance fund Pool Re, has reduced concerns about responsibility for uninsured damage, but the issue is once again topical because of uncertainties over the long-term availability of flood insurance, with landlords and tenants having to balance their relative bargaining strength against a reasonable allocation of risk in the event of uninsured flood damage occurring.

Recent years have seen developments in how uninsured risks are dealt with in commercial leases. Many institutional landlords are now offering uninsured risks provisions as a matter of course, but these must be carefully drafted, and their effect on the remainder of the lease considered, to ensure that a risk-sharing approach applies throughout the lease.

The tenant will have three primary concerns:
. ensuring that the lease rents are suspended in the event of uninsured damage
. avoiding liability for the cost of reinstatement, whether under its covenants to repair or to contribute towards service charge
. to permit early termination of the lease if the damage is not reinstated within a reasonable time

In return, landlords need to ensure that uninsured risks provisions protect their investment. In particular:
. the risks against which the landlord must insure should be qualified to the extent that those risks can be insured at reasonable rates and on reasonable terms
. the landlord should not be obliged to reinstate - since there are no insurance proceeds to call upon, reinstatement must be at the landlord's sole election, made within a time which allows the landlord to assess the damage, prepare a reinstatement strategy and source funding
. the tenant should have no ability to end the lease so long as the landlord elects to reinstate and has not failed to complete the reinstatement by an agreed date. Although the tenant will need to find temporary alternative accommodation, many landlords will need the certainty of having the tenant in place to justify the reinstatement cost and secure the necessary funding

With the prevailing uncertainty over how insurers will respond to the expiry of the Statement of Principles, uninsured risks provisions may soon become a matter of practical importance.

A fair allocation of risk has begun to emerge, but pitfalls remain for the ill-advised, by which landlords may prejudice their investments or tenants may inherit significant liability if the lease provisions are not drafted with care.