How inflation creates underinsurance risk for the food and drink sector

Inflation is on the rise globally, driven by sharply rising demand following the pandemic coupled with disrupted supply chains and labour shortages. For food and drink manufacturers and retailers this means that the value of their assets has increased substantially.

Businesses are at risk of getting into financial difficulties following a claim due to a sharp rise in inflation if the values insured are not adjusted appropriately in advance.

Significant price swings may create a widening gap between accounting valuations, which are typically discounted calculations from the original purchasing costs, and replacement values.

Companies shipping and storing commodities such as oil, gas, metals, and agricultural products are currently particularly exposed to the risk of underinsurance, but any company that handles physical assets will be affected in some way or another.

Property damage/business interruption

Due to high inflation, property damage claims are being hit particularly hard. In addition, reinstatement delays driven by extended delivery timescales are leading to further costs with lead times significantly longer than in 2020 due to delays at ports. This, combined with a global shortage of shipping containers, is leading to the ‘perfect storm’ of significant delay and exorbitant international freight costs.

The cost of labour is also on the rise and many contractors and logistics firms are now submitting multiple price variations mid-contract to account for increasing costs. There is also a general increase in contractors refusing to tender leading to lower competition and a decrease in associated deflationary pressure.

The matters described above are resulting in many reinstatement projects running overtime at a much higher cost than originally anticipated. This is leading to business interruption issues, particularly where policyholders are subject to inadequate indemnity periods.

Any significant increase in property reinstatement costs creates the potential for underinsurance. Insurers can and do reduce property claims settlements proportionately if it turns out that the sum insured is less than the actual cost of reinstatement (most notably where a policy wording does not adequately cater for the inflationary pressures noted above, e.g. “Day One Reinstatement” wordings and the presence of “Average” conditions).

Best practice would be to consider undertaking periodic professional valuations now known as Reinstatement Cost Assessments (RCA) which are adopted by the Royal Institution of Chartered Surveyors (RICS). RICS recommends that full RCAs are carried out every 3 years.

Addressing inflationary pressures

  • In advance of insurance renewal, conduct more robust reviews of reinstatement values than in recent years and consider appointing a third-party valuer to undertake an RCA.

  • Ask your broker to review current policy conditions to ensure they provide appropriate protection to help mitigate the potential for underinsurance and that they are fit for purpose.

  • Review adequacy of your business interruption indemnity period to ensure it reflects the short/medium term supply chain disruptions and potential extended lead times for key items of building materials and plant (e.g. automated platforms within fulfilment centres).

  • Aim to establish a robust business continuity plan (BCP) or challenge the assumptions of an existing BCP.

  • Consider insuring the risk based on loss limits as opposed to declared values plus XX% as the latter figure might not adequately reflect price changes.

For further information, please contact:

Debbie Day

Partner, Head of Food and Drink Practice (opens a new window)