While I understand that the developers do not wish to be completely historically accurate, for the sake of fun, this is a large historical mistake that should be fixed for the sake of history.
The current flag being used for the British Navy in the game wasn't around until 1801, when the United Kingdom brought in Northern Ireland. Piracy, however was no longer common in the 1800's the golden age of piracy was from the 1650s until the 1730s. Also In the 1850s, the blue flag that the game currently uses was designated for navy reserves, the active navy used St. George's cross.
So if this game takes place when piracy was common, 1650's to 1730's the ships of the British navy should be using this flag -> http://i.imgsafe.org/b1f84d5779.png NOT the one the game is using now. The one I linked was used from 1707-1800, This would fit in fine with the golden age of piracy.
you could also use this one http://i.imgsafe.org/b363d1ecc6.png Which is almost the same as the one used in the game, but it is the 1707 version, not the 1801 version like the one used in the game. The difference is that this one does not have a red X in the union jack, you could also use this one http://i.imgsafe.org/b37108ee03.png which is a red version, 1707 again, NOT the 1801 version.
But what is the difference between the colors?
In the 1700s there were three squadrons based on color, red, white, and blue. They have to do with rank. For example, an admiral on a blue squad ship would be lower than an admiral on the ship with a white flag, while the admiral of a ship with the red flag would be above both the blue and white ships.
So if you only wanted to use one flag, you would use the white one, or with a 3V3 you could give the highest ranking captain or the galleon the red flag, the seconds highest ranking captain the white one, and the lowest ranking captain the blue one…. would be neat, but probably easier to just use the white one for all the ships.