Consigning under-insurance to history

Inflation is a top concern for business, with higher prices for goods and services, soaring energy costs, labour shortages and supply chain disruption squeezing margins and threatening profits. It is also of primary concern for the insurance industry, which shares the risk of rising costs through increased future claims costs.

Inflation effect

Costs have been rising in almost all markets over the last 12 to 18 months, as the war in Ukraine compounded supply and demand pressures already caused by the COVID-19 pandemic. As of October 2022, annual inflation was according to the UK government's ONS data running at around 11% in both the euro zone and the UK. Even though some of these pressures are now diminishing, energy, food and commodity prices remain under pressure while wage costs continue to rise.

As a result, it is becoming more and more expensive to repair damaged properties due to higher prices of labour, materials and equipment and movement of goods. The price of key materials and components – such as steel or timber used in construction – have seen prices surge over the past year or so. Construction costs, for example, have increased 19% in Germany since the third quarter of 2019, 10% in the UK and 25% in the US, according to Zurich’s Construction Cost Indices.

Costs may also rise further following a natural catastrophe, which can trigger a surge in demand for construction materials and labour. A major property loss, such as a fire or natural catastrophe, can also drive prices higher where supply chain disruption causes a shortage of critical components or materials. A series of events, including the Texas Big Freeze and a fire at a semi-conductor plant, contributed to a global shortage of micro-chips in 2021 that continues till this day.

Business interruption

Inflation and supply chain disruption also have implications for business interruption, with a direct effect on profit margins. Higher costs affect a businesses’ bottom line, and will lead to increase revenues when they are passed on to customers.

Customers incurring a loss could experience higher business interruption values impact than originally estimated. Higher energy prices increase costs, making it more expensive to produce and transport goods and materials. Supply chain disruption can also result in longer repair and rebuild times through shortages and delays in manufacturing and shipping times.

Under-insurance

Inflation is a key issue for both insurers and insured, especially where valuations are inaccurate or out of date. Inappropriate valuations can result in under-insurance, a long-standing problem made worse by rising prices and supply chain disruption. If not addressed, under-insurance will widen the protection gap for companies and undermine the value of insurance.

For insurers, inflation is a critical driver for claims costs. Where pricing and deductibles do not adequately reflect exposures and claims trends, insurers’ capital risks being eroded. Uncertainty around inflation is also coinciding with an increase in frequency and severity of catastrophe claims, a consequence of climate change and complex supply chain dependencies.

Rigour around valuations

Going forward, it is critical to ensure valuations and appraisals are accurate and kept up-to-date. Companies should consider the rising costs for everything involved in a rebuild or repair of a property, including materials, labour, new equipment and restoration of stock. It is also important to review business interruption exposures in light of inflation and supply chain disruption.

Inflation is a challenging and complex issue. Forecasting inflation is difficult at the best of times, and is currently fraught with uncertainty. Important inflationary drivers - like material costs, labour costs and supply chain disruption – will also differ from economic inflation and their effects on individual companies with vary widely.

However, help is at hand. Various cost and price indices are available, and insurers can share their knowledge and experience, helping customers understand the impact of inflationary drivers on their exposures. Zurich, for example, has developed a number of cost trend indices to inform underwriting and provide feedback to customers.

Reviewing deductibles

Companies should anticipate in-depth conversations about inflation and valuations at their insurance renewals, as insurers seek to better understand the impact of rising prices and supply chain disruption on exposures.

Deductibles and attachment points – the relative value of which are eroded by high inflation - will be key to mitigating the impact of inflation on insurance. Insufficient deductibles and attachment points would have implications for premium rates and coverage offered by insurers. Accurate valuations, however, will help underwriters to set appropriate deductible levels and attachment points, which in turn enables insurers to unlock capacity.

For many customers, high inflation is likely to result in higher exposures, with a likely knock-on effect for insurance premiums and limits. There are, however, actions that companies can take to mitigate the effects of inflation on their insurance programmes, such as reviewing deductible levels, coverage and non-essential extensions.

Rewarding resilience

In addition to values, insurers will continue to monitor the quality of insured assets, risk management and business continuity. Companies that can demonstrate implementation of risk management actions to improve the overall risk profile, will send a positive message to insurers about their ability to control risk, which should translate to coverage terms and capacity.

Business continuity planning and management, however, has become more challenging for companies. At Zurich we have recognized the need to support our customer with our Zurich Resilience Solutions to provide services for companies to improve resilience in an ever-changing risk landscape.

Embedding best practices

Inflationary pressures are not about to go away. While inflation is forecast to moderate over the next few years, energy and labour costs are likely to remain elevated for the foreseeable future.

Irrespective of the inflationary environment, the practice of maintaining accurate and timely valuations needs to be embedded for the long term. By working with insurers and brokers, customers can obtain a robust view of exposures and ensure they have appropriate levels of cover.

Originally published in Commercial Risk on December 6, 2022