Rising inflation is impacting prices across all sectors of the economy. As a result, replacement costs may be higher than expected following a claim, leaving some commercial insurance holders underinsured.
The conflict in Ukraine is fuelling inflation, which is now expected to remain elevated for longer than previously forecast on higher commodity costs and broader price pressures, according to a recent International Monetary Fund (IMF) blog (opens a new window). After a revision, the organisation expects consumer prices to increase by 5.7 percent in 2022 in advanced economies and 8.7 percent in emerging market and developing economies. This comes on the back of Covid-19-induced inflation caused by supply bottlenecks due to factory closures, port restrictions, shipping congestion, container shortages and worker absences.
A wide range of materials and products have significantly increased in value during the last 12 months, including construction materials, electronics, precious metals, and renewables. Prices for widely used raw materials such as steel or copper have been very volatile with some significant spikes.
For companies affected, this 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. For companies operating in commercial property, for example, the cost to repair or rebuild structures following a loss has soared significantly. It’s not only the materials’ prices that have gone up due to supply chain issues, but also higher labour costs will add to the bill caused by worker shortages.
Inflationary pressures are bringing new challenges to all lines of property and casualty (P&C) insurance cover. Here we examine what is driving increasing costs in each major class and how these challenges can be addressed.
1. Property damage/business interruption
Property damage claims are being hit particularly hard as a result of international shortages in timber, steel, cement, metals and plastics. Iron ore for example has seen an 88% price increase over the past 12 months, with timber, steel and plaster all increasing by at least 20 – 30%.
In addition, reinstatement delays driven by extended delivery timescales are leading to further costs with many items taking twice or even three times as long to arrive than in 2020. The UK imports 64% of building materials from the EU. Delays at ports and undertaking customs procedures are having an inevitable effect on how long these materials take to arrive on site. This, combined with a global shortage of shipping containers, is leading to the ‘perfect storm’ of significant delay and exorbitant international freight costs.
An increase in housebuilding and infrastructure projects is driving the cost of labour higher with many contractors 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 shorter maximum indemnity periods (particularly those with 12 months of cover).
Any significant increase in property reinstatement costs creates the potential for underinsurance. Being underinsured has important consequences. Insurers can and do reduce property claims settlements proportionately if it turns out that the sum insured is less than the actual cost of reinstating (and your 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. Updated RCAs should be undertaken whenever there are significant changes to buildings or investment/downsizing in the plant and machinery/contents.
In the UK, the new Judicial College guidelines (which set the value brackets for injury claims) were published on 11thApril. The figures in the latest edition reflect the 6.56% increase in retail price index (RPI) since the 15th edition and are given as neatly rounded figures. This will undoubtedly cause an increase in all injury valuations.
Inflationary pressures are being seen in high value injury claims as a result of wage increases (particularly the cost of care), developments and the associated cost of new technology in prosthetics, an increase in the volume of chronic pain and subtle brain injury claims and the increased prevalence of accommodation claims (where an injured party alleges they need to move home as a result of the incident).
Re-assessment of the guideline hourly rates (that solicitors are able to claim with respect to their fees) which took place in 2021 in the UK are also likely to impact 2022 values, with an average increase of 17.7% applied from the pre-2021 figures.
The cost-of-living crisis is expected to drive further increases in claims volumes and fraudulent claims as those under financial pressures are more alert to the possibility of pursuing financial claims from employers or third parties.
A significant reduction in the manufacture of new vehicles during the COVID-19 pandemic has led to pressure on second hand car markets and replacement parts. Significant delays in the delivery of parts and new vehicles are causing extended claim periods which lead to increased storage, hire and replacement vehicle costs. In addition, the increased sophistication of vehicles and the worldwide shortage of microchips means repairs are generally more complicated and costly. According to the Association of British Insurers (ABI), between 2015 and 2020, the average amount paid for damage to policyholders’ vehicles increased by 59%, and the average paid to third parties for damage to their vehicles rose by 32%.
In addition to raw material increases the industry has seen general inflationary pressure on labour costs. In the UK, Brexit has contributed to this development, but there is also higher demand for non-mechanical expertise, particularly when repairing sophisticated electric vehicles or newer vehicles which are highly reliant upon sensors, complex technology and software.
In the UK, the move to much lower whiplash tariffs in 2021 through the new Official Injury Claim (OIC) system is unsurprisingly beset with problems. Whilst the stated aims of the process were to promote litigants in person, nine out of ten claimants continue to use a legal representative of sorts to pursue their claims. Only around one third of claimants allege they have sustained injuries which are bound by the tariffs with many alleging multi-site injuries (e.g. a whiplash injury coupled with a soft tissue injury to the arm). It is unclear how such claims should be valued, leading to many claims going unresolved. ABI test cases on how the injury valuations should be undertaken are expected in 2022.
Finally, an increased prevalence of collisions involving vulnerable road users has been noted as a result of increases in the use of bicycles and electric scooters. According to the Transport for London, electric scooters are now involved in 2.5% of all collisions in London. These collisions can lead to very serious injuries which in turn result in very costly claims.
A myriad of global and national issues is working in unison to cause significant issues in the P&C claims arena. These issues are unlikely to resolve in 2022 although there is some hope that regulatory changes (such as the ‘bedding in’ of the whiplash reforms in the UK) and the reignition of global markets and supply chains following the COVID-19 pandemic will begin to ease pressures in 2023. In the meantime, practitioners and clients must be aware of the fact that claims are likely to take longer to resolve and will be considerably more costly than in 2021. Placement decisions should consider these issues carefully, particularly when determining appropriate deductible, aggregate and maximum indemnity period levels.
Mitigating the impact of inflationary pressures
1. Property damage/business interruption
In advance of insurance renewal, conduct more robust reviews of reinstatement values than in recent years and consider appointing 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).
Consider establishing a robust business continuity plan (BCP) or challenge the assumptions of an existing BCP.
Review appropriateness and efficiency of your liability deductibles and policy limits – in addition to the factors highlighted above there is a need to consider “social inflation”, e.g. the rising costs of insurance claims resulting from things like increasing litigation, broader definitions of liability and more plaintiff-friendly legal decisions. This means that adequate policy limits from two/three years ago may need uplifting to keep pace.
Consider the use of broker analytical tools to assess policy limit v probability of exhausting the limit and economic cost of risk (ECoR) modelling for choosing the optimum deductible level and assessing the continued efficiency of your casualty insurance programme.
If not already established, consider setting up a motor fleet risk management steering group with support from your broker and insurer. Key objectives of such a group will include identifying strategies which will be effective in reducing motor fleet risk and motor fleet claims costs.
Develop a safety culture within your fleet.
Focus on reducing accident frequency: By reducing collision rates you will be lowering the ultimate claims cost.
The use of telematics can play a significant part in an overall risk management strategy.
Technology such as dashboard and CCTV cameras help determining quickly who was at fault.
Work with third party providers and/or your insurer/broker to improve First Notification Of Loss (FNOL) and third party capture. This will help reduce claims costs such as credit hire charges.
For further information, please contact:
Michael Kay, Head of Retail Practice Group
T: +44 (0)161 828 3304