Technology and the Internet have both good and bad sides, whether it’s for businesses or consumers. Many opportunities have been created, such as access to global markets, cheaper and easier transport and communication and better sources of supply. But with this opportunity comes threats, especially for businesses. We’ve seen the emergence of new online-based companies and in some cases these have contributed to the demise of other firms. In this News Item we look at the impact on the newspaper industry.

Media is one industry that has been significantly affected by technological developments. Newspaper readership has been in decline for many years and this is even the case for the most widely read UK paper – The Daily Telegraph. However, according to Seamus Dooley, Irish secretary of the National Union of Journalists, it’s not the end of the industry:

It is an industry in crisis, but I don’t accept it is an industry in terminal decline.

More and more information has become freely available online and just as we would expect in any other sector, the newspaper industry has had to respond. To keep their readers, newspapers across the world provide thousands of articles on all topics on their websites. But if news can be accessed freely, why bother purchasing a newspaper? This is the problem facing the Daily Telegraph, the Independent, the Daily Mail etc – the number of newspapers sold has declined and thus so have revenues and profits.

One option is to charge consumers for reading the news by introducing a subscription to the online articles. The Financial Times already charges a fee to view articles online beyond a certain number and The Telegraph is soon to follow suit. Back in 2010, The Times and Sunday Times launched their new websites, which charged readers for viewing articles. The model being adopted by The Telegraph is a little different, as a certain number of articles can be viewed for free before a price must be paid. International readers are already charged to view online material, but these new charges will apply to UK readers. With so much competition facing newspapers, the number of readers for The Telegraph will undoubtedly decline, but with newspaper readership falling, revenues must come from somewhere. Tony Gallagher has said:

We want to develop a closer rapport with our digital audience in the UK, and we intend to unveil a number of compelling digital products for our loyal subscribers in the months ahead.

Differentiating the product is going to be essential for any newspaper that begins charging, as with so much information available online for free, they have to ensure they keep their readers. Establishing loyalty will be crucial. The following articles consider this change.

Telegraph extends paywall to UK readers BBC News (26/3/13)
The Telegraph: subscribe to Britain’s finest journalism The Telegraph (26/3/13)
Telegraph to put up metered paywall Guardian, Roy Greenslade (26/3/13)
The sun joins Telegraph in charging website users The Guardian, Lisa O’Carroll and Roy Greenslade (26/3/13)
Oh how Times are charging Sloman News Site March 2010
Telegraph introduces UK paywall Marketing Week, Lara O’Reilly (26/3/13)
Washington Post announces porous paywall Journalism.co.uk, Sarah Marshall (19/3/13)
Washington Post latest newspaper to put faith in paywalls The Guardian, Dominic Rushe (19/3/13)
Ireland’s newspapers suffer hard times Financial Times, Jamie Smythe (24/3/13)
Washington Post to start charging for website Wall Street Journal, Keach Hagey (18/3/13)

Banks in Cyprus are in crisis. They have many bad debts e.g. to Greece and as mortgages in a falling property market. Private-sector debts have become unsustainable for the banks. The problem is compounded by negative economic growth and large government deficits (see chart). But, as with Icelandic banks back in 2008, this means a crisis for the whole country.

The reason is that the banking sector in Cyprus, as in Iceland and Ireland too, is large relative to the whole economy – over 8 times annual GDP (second only to Ireland in the EU). Loans to Greece alone are as much as 160% of Cyprus’ GDP and Cypriot banks were badly hit by the terms of the Greek bailout, which required creditors to take a 53% reduction (or ‘haircut’) in the value of their loans to Greece. With such a large banking sector, it is impossible for the Cypriot government alone to rescue the banks.

Cyprus thus turned to the EU for a bailout: back in June 2012. This makes Cyprus the fifth country to seek a bailout (after Greece, Ireland, Portugal and Spain). A bailout of €10 billion has just been agreed by the EU and IMF. The bailout comes with the ‘usual’ conditions of strong austerity measures of tax rises and cuts in government expenditure. But what makes this bailout different from those given to the other countries was a proposed levy on savers.

The proposal was that people with up €99,999 in their bank accounts (of any type) would face a one-off tax of 6.75%. The rate for those with €100,000 or more would be 9.9%, including on the first €99,999. This would raise around €5.8 billion of the €10 billion.

Not surprisingly, there was a public outcry in Cyprus. People had thought that their deposits were protected (at least up to €100,000). There was a run on cash machines, which, as a result were set to deliver just small amounts of cash to cope with the excessive demand. There was huge pressure on the Cypriot government not to introduce the measure.

But the ramifications of the proposed levy go well beyond the question of justice to savers. Questions are being raised about its incentive/disincentive effects. If people in other countries in future financial difficulties felt that they might face similar levies, how would they behave? Also, there is no haircut being proposed for holders of banks’ bonds. As Robert Peston states in his first article below:

The Cypriot deal sets back the cause of the new global rules for bringing order to banking systems when crisis hits. Apart from anything else, in other eurozone countries where banks are weak, it licenses runs on those banks, as and when a bailout looms.

But getting incentives right is not easy. As the Buttonwood column in The Economist points out:

The problem is tied up with the issue of moral hazard. This can be applied to both creditors and debtors; the former should be punished for reckless lending and the latter for living beyond their means. The collapse of Lehman Brothers is seen as an example of the faulty reasoning behind moral hazard; by letting the bank go bust, the crisis was spread throughout the financial system. But rescuing every creditor (or intervening to bail out the markets every time they falter) is the reason we are in this mess.

One alternative considered by the Cyprus parliament was to exempt people with less than €20,000 in their accounts from the levy. But this was rejected as being insufficient protection for savers. Another is to exempt people with less than €100,000, or to charge people with between €20,000 and €100,000 at a lower rate or rates.

But charging less, or nothing, on deposits of less than €100,000 would make it harder to to raise the €5.8 billion required by the EU. Without alternative measures it would mean charging a rate higher than 9.9% on larger deposits. The Cypriot government is afraid that this would discourage inward investment. Russia, in particular, has invested heavily in the Cyprus economy and Russia is campaigning vigorously to limit the size of the levy on large deposits. But there is little sympathy for Russian depositors, much of whose deposits are claimed to be ‘laundered money’. The Cypriot government has been seeking financial support from the Russian government.

An alternative proposal being considered is to issue government bonds in an “investment solidarity fund” and to transfer pension funds from semi-public companies to the state. Also Russia may be willing to invest more money in Cyprus’ offshore oil and gas fields.

Agreement
A deal was struck between Cyprus and the EU/IMF early in the morning of 25 March, just hours before the deadline. For details, see the News Item Cyprus: one crisis ends; another begins.

Webcasts and podcasts
Eurozone ministers agree 10bn euro Cyprus bailout Channel 4 News (16/3/13)
Bailout is ‘blackmail’ claims Cyprus president Euronews (17/3/13)
Cyprus’s president tries to calm fears over EU bailout The Guardian (18/3/13)
Cypriot bank customers reactions to savings levy BBC News (17/3/13)
Cyprus bailout: Parliament postpones debate amid anger BBC News (17/3/13)
Cyprus parliament delays debate on EU bailout Al Jazeera (17/3/13)
Cyprus told it can amend bailout, as key vote postponed BBC News, Gavin Hewitt (18/3/13)
Robert Peston: Cyprus bailout an ‘astonishing mess’ BBC News, Robert Peston (18/3/13)
Cyprus bailout is ‘completely unfair’ BBC Radio 4 Today Programme, Michael Fuchs and Bernadette Segol (18/3/13)
Lenders ‘doing everything you should not do’ on Cyprus BBC Radio 4 Today Programme, Alistair Darling (19/3/12)
Cyprus warned over bailout rejection BBC News (20/3/13)

Articles
Cyprus becomes fifth eurozone bailout The News International (Pakistan) (17/3/13)
Cyprus bailout deal sparks run on ATMs Irish Independent (17/3/13)
EU leaders gamble in Cyprus bank bailout BBC News, Gavin Hewitt (17/3/13)
Cyprus told it can amend bailout, as key vote postponed BBC News (18/3/13)
Q&A: Cyprus bailout BBC News (19/3/13)
Cyprus’ President Defends Bailout Deal The Motley Fool (16/3/13)
Sad Cyprus The Economist, Buttonwood’s Notebook (12/3/13)
The Cypriot bail-out: A fifth bitter lemon The Economist (30/6/12)
Analysis: Cyprus bank levy risks dangerous euro zone precedent Reuters, Mike Peacock (17/3/13)
The Cyprus precedent Reuters, Felix Salmon (17/3/13)
The Cyprus Bank Bailout Could Be A Disastrous Precedent: They’re Reneging On Government Deposit Insurance Forbes, Tim Worstall (16/3/13)
Cyprus rescue breaks all the rules BBC News, Robert Peston (18/3/13)
Cyprus and the eurozone’s survival BBC News, Robert Peston (20/3/13)
Eurogroup defends Cyprus bail-out The Telegraph (17/3/13)
Cyprus eurozone bailout prompts anger as savers hand over possible 10% levy The Guardian (16/3/13)
Cyprus’s wealth tax makes perfect sense – its rich won’t escape unscathed The Guardian, Phillip Inman (18/3/13)
The tragedy of Cyprus The Real Economy blog, Edmund Conway (16/3/13)
Damage limitation in Cyprus BBC News, Stephanie Flanders (19/3/13)
The fatal flaw in the eurozone’s not-so-cunning plan for Cyprus The Guardian, Larry Elliott (19/3/13)
Cyprus plans special fund in race to get EU-IMF bailout BBC News, (21/3/13)
Cyprus says ‘significant progress’ in debt crisis talks BBC News (23/3/13)

Background information
The Banking System in Cyprus: Time to Rethink the Business Model? Cyprus Economic Policy Review, Vol. 5, No. 2, pp. 123–130, Constantinos Stephanou (2011)
European sovereign-debt crisis Wikipedia

As part of the Basel III round of banking regulations, representatives of the EU Parliament and member governments have agreed with the European Commission that bankers’ bonuses should be capped. The proposal is to cap them at 100% of annual salary, or 200% with the agreement of shareholders. The full Parliament will vote in May and then it will go to officials from the 27 Member States. Under a system of qualified majority voting, it is expected to be accepted, despite UK resistance.

The main arguments in favour of a cap are that it will reduce the focus of bankers on short-term gains and reduce the incentive to take excessive risks. It will also appease the anger of electorates throughout the EU over bankers getting huge bonuses, especially in the light of the recession, caused in major part by the excesses of bankers.

The main argument against is that it will drive talented top bankers to countries outside the EU. This is a particular worry of the UK government, fearful of the effect on the City of London. There is also the criticism that it will simply drive banks into increasing basic salaries of senior executives to compensate for lower bonuses.

But it is not just the EU considering curbing bankers’ pay. The Swiss have just voted in a referendum to give shareholders the right to veto salaries and bonuses of executives of major companies. Many of these companies are banks or other financial sector organisations.

So just what will be the effect on incentives, banks’ performance and the movement of top bankers to countries without such caps? The following videos and articles explore these issues. As you will see, the topic is highly controversial and politically charged.

Meanwhile, HSBC has revealed its 2012 results. It paid out $1.9bn in fines for money laundering and set aside a further $2.3bn for mis-selling financial products in the UK. But its underlying profits were up 18%. Bonuses were up too. The 16 top executives received an average of $4.9m each. The Chief Executive, Stuart Gulliver, received $14.1m in 2012, 33% up on 2011 (see final article below).

Webcasts and podcasts
EU moves to cap bankers bonuses Euronews on Yahoo News (1/3/13)
EU to Curb Bank Bonuses WSJ Live (28/2/13)
Inside Story – Curbing Europe’s bank bonuses AlJazeera on YouTube (1/3/13)
Will EU bonus cap ‘damage economy’? BBC Radio 4 Today Programme (28/2/13)
Swiss back curbs on executive pay in referendum BBC News (3/3/13)
Has the HSBC scandal impacted on business? BBC News, Jeremy Howell (4/3/13)

Articles
Bonuses: the essential guide The Guardian, Simon Bowers, Jill Treanor, Fiona Walsh, Julia Finch, Patrick Collinson and Ian Traynor (28/2/13)
Q&A: EU banker bonus cap plan BBC News (28/2/13)
Outcry, and a Little Cunning, From Euro Bankers The New York Times, Landon Thomas Jr. (28/2/13)
Bank bonuses may shrink – but watch as the salaries rise The Observer, Rob Taylor (3/3/13)
Don’t cap bank bonuses, scrap them The Guardian, Deborah Hargreaves (28/2/13)
Capping banker bonuses simply avoids facing real bank problems The Telegraph, Mats Persson (2/3/13)
Pro bonus The Economist, Schumpeter column (28/2/13)
‘The most deluded measure to come from Europe since fixing the price of groceries in the Roman Empire’: Boris Johnson attacks EU banker bonus cap Independent, Gavin Cordon , Geoff Meade (28/2/13)
EU agrees to cap bankers’ bonuses BBC News (28/2/13)
Viewpoints: EU banker bonus cap BBC News (28/2/13)
Voters crack down on corporate pay packages swissinfo.ch , Urs Geiser (3/3/13)
Swiss voters seen backing executive pay curbs Reuters, Emma Thomasson (3/3/13)
Swiss referendum backs executive pay curbs BBC News (3/3/13)
Voters in Swiss referendum back curbs on executives’ pay and bonuses The Guardian, Kim Willsher and Phillip Inman (3/3/13)
Swiss vote for corporate pay curbs Financial Times, James Shotter and Alex Barker (3/3/13)
HSBC pays $4.2bn for fines and mis-selling in 2012 BBC News (4/3/13)

Australia is a rich country. It is one of the few to have avoided a recession. This has been the result partly of successful macroeconomic policies, but largely of the huge mining boom, with Australia exporting minerals to China and other fast growing Asian economies.

But has this growth brought happiness? Are Australians having to work harder and harder to pay for their high standard of living? Indeed, do higher incomes generally result in greater happiness? The following articles explore this issue, both in an Australian context and more broadly. They look at some recent evidence.

For example, in one study, Canadian, Chinese, Indian, and Japanese university students were asked what they held to be most important for assessing the worth of their lives. The crucial finding was that although higher incomes may be a contributing factor to increased happiness and well-being, especially for poorer people, other factors are more important. These include developing fulfilling personal relationships, whether with partners, family members or friends; gaining knowledge and wisdom; having enjoyable hobbies; having financial security (as opposed to higher incomes); having a worthwhile career; living a moral life; helping other people.

The question then arises whether our economic systems and incentives are geared towards achieving these outcomes. Or are we encouraged to consume more and more and to seek higher and higher incomes to feed our addiction to consumption?

Is there an information problem here? Do many individuals perceive that money will buy them happiness, whereas, in reality, money can’t buy them love?

Articles
Australia: Where the good life comes at a price BBC News Magazine, Madeleine Morris (24/2/13)
Australia has the know-how to boost wellbeing Sydney Morning Herald, Matt Wade (8/9/12)
Money can’t buy you the good life Independent, Roger Dobson (24/2/13)
The 10 Things Economics Can Tell Us About Happiness The Atlantic, Derek Thompson (31/5/12)
Yes, Money Does Buy Happiness: 6 Lessons from the Newest Research on Income and Well-Being The Atlantic, Derek Thompson (10/1/13)
The fact is, the richer you are, the happier you are The Telegraph, Allister Heath (5/2/13)
Money buys happiness? I wouldn’t bank on it The Telegraph, Christopher Howse (6/2/13)
Who Says Wealth Doesn’t Buy Happiness? The Wealthy Do CNBC, Robert Frank (4/2/13)
More Proof That Money Can’t Buy Happiness Business Insider, Aimee Groth (28/1/13)
Money Changes Everything The New York Times, Adam Davidson (5/2/13)
Why are the Chinese so sad? Maclean’s (Canada), Mitch Moxley (4/2/13)

Reports
First World Happiness Report Launched at the United Nations The Earth Institute, Columbia University (2/4/12)
World Happiness Report The Earth Institute, Columbia University, John Helliwell, Richard Layard and Jeffrey Sachs (eds.) (2/4/12)
Well-being evidence for policy: A review New Economics Foundation, Laura Stoll, Juliet Michaelson and Charles Seaford (3/4/12)

Everyone who drives in the UK is required to take out car insurance. Whilst fully comprehensive is voluntary, it is compulsory to have at least third party insurance, which covers damage to other vehicles. Insurance premiums are calculated based on a number of different variables, such that two people driving the same car may face wildly different costs.

Although there are many insurance companies to choose from, this industry has been referred to the Competition Commission by the OFT as it was ‘worried the structure of the market was making costs and premiums unnecessarily high.’

According to Moneysupermarket, the average cost of car insurance reached a high of £554 in April 2011, but have fallen by £76 since. With tight incomes across the UK for many families, high car insurance premiums is another strain and thus this investigation will come at an apt time, even though the findings of the CC may not be reported for 2 years. The Association of British Insurers (ABI) said that the investigation would:

‘bring much-needed reforms to the market that will, in turn, result in lower car insurance premiums for consumers’.

The problem seems to be that when an individual is involved in an accident and sends their car off for repairs, their insurance company doesn’t have much control over the bills they end up paying, which can be inflated by £155 each time. This therefore leads into higher costs for the insurance company, which are then passed on the driver in the form of an increased premium. Other concerns were that courtesy cars were being offered, at an estimated cost of £560 per vehicle (according to the OFT) and that drivers were using these cars for longer than necessary, once again causing costs to rise.

Altogether, it has been suggested that the actions of the insurance company of ‘not-at-fault’ drivers, car hire companies, repairers and brokers push up the prices for ‘at-fault’ drivers’ insurance companies. Given that any insurance company is just as likely to be the ‘at-fault’ insurance company, they all face rising costs.

Back in May, the OFT had already decided that the car insurance market required a more detailed investigation, because of the ‘dysfunctionality’ of the market. Following a public consultation, the industry will now face an investigation by the CC. One additional area that may be of interest to the CC came to light last year, where it was found that insurance companies were claiming against themselves in a bid to drive up premiums. Although the investigation will take some time, it is still a timely review for many drivers, who have seen the cost of motoring reach record highs. The following articles consider the market for car insurance.

Car insurance market referred to Competition Commission BBC News (28/9/12)
No quick fix for motor insurance abuses, says watchdog Independent, Simon Read (29/9/12)
Car insurance industry faces probe The Press Association (28/9/12)
Competition Commission referral will take time to lower motor insurance premiums The Telegraph, Rosie Murray-West (28/9/12)
UK car insurance probe over-shadows Direct Line IPO Reuters, Matt Scuffham and Myles Neligan (28/9/12)
Car insurance scrutinized over high premiums Sky News (28/9/12)
Rip-off motor insurance firms face competition watchdogs probe over £225million racket Mail Online, Ray Massey (28/9/12)

A recent article on this blog discussed the likelihood that we will soon move to a cashless society. It is therefore interesting to consider the implications that this might have for consumer behaviour. We might expect the form of payment to make no difference to a rational consumer. However, there is considerable evidence to suggest that this is not the case.

One reason why people appear to spend more freely on credit cards is payment decoupling – you get utility from the item purchased before you pay the cost. However, more recent evidence suggests that this is not the only relevant factor. It appears that the degree of transparency of the payment method also has an effect. Psychologists quoted in the above article conclude from their experimental evidence that:

Payment modes differ in the transparency with which individuals can feel the outflow of money. ….with cash being the most transparent payment mode.

This effect also appears to make people spend cash less freely.

The author of the above article spent some time experimenting with trying to make all his purchases using cash. He found that by doing so, he was able to reduce his spending by about 10%. However, this seems likely to become harder to do in the future and, as the article concludes, it is already difficult to purchase some items with cash.

Why does foreign money seem like play money? Science Codex (04/06/07)

A recent post on this blog referred to what sounds a fascinating new book, What Money Can’t Buy: The Moral Limits Of Markets, by Michael Sandel. The Guardian also recently featured an extract from this book.

As the earlier blog post discussed, our lives are now dominated by markets. Economists typically believe markets are the best way to allocate resources as, if the market mechanism works correctly, the resulting equilibrium maximizes economic welfare as measured by the sum of consumer and producer surplus. In particular, all consumers that are willing to pay a price above the market price are able to buy the product.

Fundamental to the measurement of consumer welfare is the notion that consumers will be prepared to buy a product as long as their willingness to pay exceeds the price. It therefore follows that consumers are more likely to buy the product as the price falls and, if they do so, gain increasing surplus. However, the extract from Michael Sandel’s book provides a number of interesting examples which suggest that in some situations this might not be the case.

One example concerns the storage of nuclear waste in Switzerland. When surveyed, 51% of the residents of the small Swiss village of Wolfenschiessen, said that they would be prepared to accept the waste being stored nearby. However, somewhat surprisingly, this figure fell to 25% when the residents were told that they would be compensated for the inconvenience. Furthermore, the figure remained at this low level even when the proposed compensation was increased to over £5000 per person.

Sandel argues that this is because, once compensation is introduced, financial incentives crowd out public spirit. He suggests that:

putting a price on the good things in life can corrupt them.

For economists, this potentially has important implications for how we evaluate market outcomes and our belief that the market equilibrium is always the optimal outcome. Furthermore, it suggests that in some circumstances allowing the market mechanism to allocate resources may not be the ideal solution.

What money can’t buy – review The Guardian, John Lanchester (17/05/12)
Michael Sandel: ‘We need to reason about how to value our bodies, human dignity, teaching and learning’ Guardian, Decca Aitkenhead (27/5/12)
We must decide on the way we want to live now London Evening Standard, Matthew d’Ancona (23/05/12)

The trendy US fashion retailer Abercrombie & Fitch entered the UK in 2007 with the opening of a flagship store close to Savile Row in London. Located in the upmarket Mayfair area of London, Savile Row is famous for its traditional men’s tailors.

Recently Abercrombie & Fitch decided to go one step further by opening a childrenswear store directly on Savile Row. This move upset the local retailers and was met with protests.

This was just the latest in a history of controversy surrounding Abercrombie & Fitch which has included a product boycott and a lawsuit concerning employment issues. Should all this bad publicity be a concern for the company?

We expect tastes to be one of the key determinants of demand. If taste for a company’s product declines, its demand curve shifts to the left. This means it can sell less at any given price and consequently will have a knock-on effect on profits. Somewhat surprisingly, therefore, the PR expert, Mark Borkowski, quoted in the Guardian article above, suggests that all this adverse publicity may have in fact helped the company because:

“…the focus is on the brand. They’ve got a very keen identity of who they are, what they want, who they want to consume their products, and they’ve stuck to it.”

It is also clear that the company is very aware of the importance of protecting its brand – even going as far as paying television actors NOT to wear their clothes! Abercrombie & Fitch has also been reluctant to cut its prices during the current recession, perhaps because of a fear of harming its brand.

Abercrombie & Fitch with its ‘crappy clothes’ threatens staid Savile Row Observer, Euan Ferguson (11/03/12)
Savile Row cannot live in the past Guardian, Charlie Porter (24/04/12)
Sorry chaps, Abercrombie & Fitch simply doesn’t fit Savile Row Guardian, Gustav Temple (24/04/12)
Savile unrest … the tailors who want to stop Abercrombie & Fitch London Evening Standard, Josh Sims (27/04/12)

How much value do you place on that wonderful long weekend that a Bank holiday brings? The extra lie in; the ensuing 4 day week; the time you spend with your family. Some would say it’s invaluable – you can’t put a price on it. But those some people would not be economists! Each Bank holiday is worth about £2bn – at least that’s how much it costs the economy.

According to the Centre for Economics and Business Research, if the UK got rid of its Bank holidays, GDP would increase by approximately £18bn.

Some businesses will do well out the Bank holidays, but according to the research, the sectors of the economy that suffer are far greater, causing losses in productivity and hence in GDP. Indeed, the extra Bank Holiday we had last year for the Royal Wedding is thought to have been part of the cause for the slow down in growth to 0.1% during the second quarter of 2011.

Based on this data, there are unsurprisingly concerns that the extra Bank holiday this year for the Queen’s Diamond Jubilee could also cost the economy. Not particularly good news, considering how vulnerable the economy currently is. Although the Queen’s Diamond Jubilee will undoubtedly generate huge amounts of spending, it is thought that this will be more than offset by the sectors that are expected to lose out because of the loss in working hours and hence productivity.

Given the cost of Bank holidays to the economy, the CEBR says that they should be spread more evenly throughout the year. Is this the solution &ndash if one is needed – or should they be abolished altogether! The following articles consider the issue.

Do we really need bank holidays? Asks CEBR Telegraph, Emily Gosden (30/10/11)
Bank holidays ‘cost economy £18bn’ Independent, John Fahey (9/4/12)
Bank holiday costs UK economy £2.3bn Sky News, Tadhg Enright (9/4/12)
Bank holidays ‘cost economy £19bn’ BBC News (9/4/12)
Bank holidays cost UK economy £18bn and ‘should be spread out’ Mail Online (9/4/12)

Next year a government agreement with insurance companies is set to end. This agreement requires insurance companies to provide cover for homes at a high risk of flooding.

However, in June 2013, this agreement will no longer be in place and this has led to mounting concerns that it will leave thousands of home-owners with the inability either to find or afford home insurance.

The key thing with insurance is that in order for it to be provided privately, certain conditions must hold. The probability of the event occurring must be less than 1 – insurance companies will not insure against certainty. The probability of the event must be known on aggregate to allow insurance companies to calculate premiums. Probabilities must be independent – if one person makes a claim, it should not increase the likelihood of others making claims.

Finally, there should be no adverse selection or moral hazard, both of which derive from asymmetric information. The former occurs where the person taking out the insurance can hide information from the company (i.e. that they are a bad risk) and the latter occurs when the person taking out insurance changes their behaviour once they are insured. Only if these conditions hold or there are easy solutions will the private market provide insurance.

On the demand-side, consumers must be willing to pay for insurance, which provides them with protection against certain contingencies: in this case against the cost of flood damage. Given the choice, rational consumers will only take out an insurance policy if they believe that the value they get from the certainty of knowing they are covered exceeds the cost of paying the insurance premium. However, if the private market fails to offer insurance, because of failures on the supply-side, there will be major gaps in coverage.

Furthermore, even if insurance policies are offered to those at most risk of flooding, the premiums charged by the insurance companies must be high enough to cover the cost of flood damage. For some homeowners, these premiums may be unaffordable, again leading to gaps in coverage.

In light of the agreement coming to an end next year, there is pressure on the government firstly to ensure that insurance cover is available to everyone at affordable prices and secondly to continue to build up flood defences in the most affected areas. Not an easy task given the budget cuts. The following articles provide some of the coverage of the problems of insuring against flood damage.

200,000 homes ‘at flooding risk’ BBC News (3/1/12)
MPs slam government flood defences Post Online, Chris Wheal (31/1/12)
Flooding: 200,000 houses at risk of being uninsurable The Telegraph (31/1/12)
Flood defences hit by government cuts ‘mismatch’, says MP Guardian, Damian Carrington (31/1/12)
Fears over cash for flood defences The Press Association (31/1/12)
ABI refuses to renew statement of principles for flood insurance Insurance Age, Emmanuel Kenning (31/1/12)