The insurance industry is deeply concerned that the Government is leaning towards mandating compulsory flood cover – and it has every right to be concerned.

While the remit of John Trowbridge’s Natural Disaster Insurance Review is to look for insurance solutions to the flood problem, the industry should be alarmed about what appears to be an apparent lack of joined-up thinking between this review and the various other Government initiatives, discussion groups and working parties looking at other aspects of the flood problem.

The solution to preventing a repeat of what happened in Queensland in January is not just an insurance one. Implemented alone, forcing a free market to underwrite a product which in some areas is inherently high-risk – without providing it with tools to manage and measure those risks – is deeply unfair.

Without at least some investment in flood mapping and the implementation of better building codes and tighter planning controls in flood-prone areas, the industry will be forced to write a cover that runs counter to the very business model that allows insurers to take on risks while remaining stable enough to meet their claims obligations.

The industry mantra – if you can’t rate it, don’t write it – will have to be thrown out the window as some insurers are forced to offer cover for risks that they cannot afford to price soundly.

Merrill Lynch research analyst Andrew Kearnan’s report on the situation has gained considerable industry attention. He suggests that smaller players in the home market will be unfairly disadvantaged and in some cases could price themselves out of flood risks by effectively – or expressedly – withdrawing from the home market entirely.

That would only serve to reduce consumer choice and drive up premiums.

IAG, which does offer flood cover in some states, says compulsion, particularly if high-risk properties are subsidised, would fail to send a message to consumers about building in flood-prone areas.

CEO Mike Wilkins told the Australian Financial Review last week that just 2-3% of Australian homes would have problems getting cover because of their high flood risk – a figure that would be reduced to around 1% “if the right flood-mapping data was made available”.

Even Suncorp, which has invested heavily in flood risk assessment to allow it to offer flood cover as standard in most of its home insurance policies, is against the full flood plan. It says the principle of forcing insurers to take on risks beyond their risk threshold is unfair, and that introduced in isolation, compulsory flood cover “would not increase accessibility or affordability for consumers”.

While other potential avenues will be proposed by the Natural Disaster Insurance Review, Mr Trowbridge, as chairman, has made it clear that the “full flood” solution is the one his committee most strongly advocates.

It’s an understandable solution from the viewpoint of “classic” insurance, where the risk is spread throughout the pool to make the larger risks economically coverable. All insurers selling home insurance would be required to offer flood cover on all properties, and all consumers buying home insurance would be required to buy flood cover.

Problem solved? Who can tell? The flood insurance reforms being pursued by Assistant Treasurer Bill Shorten are, at this stage, not totally clear. Nor is it clear that the reforms would deter some insurers from staying in the market.

The Merrill Lynch report notes that the cross-subsidisation of high-risk zones “might encourage further high-risk developments, and could possibly provide advantages for insurers which choose not to offer flood cover”.

The personal lines market is a different and very modern beast, where competition is tough and products of all types and sizes search for customers through increasingly sophisticated sales channels. The “one-size-fits-all” proposal favoured by the committee would sit untidily with the market’s “products for every type of buyer” approach.

As Mr Kearnan observes in his report, “this is going to be a complex debate with a number of competing objectives including affordability, sustainability, self-funding versus Government/taxpayer funding.

The insurance industry has every reason to be worried.