The Impact of Inflation on Your Insurance
Inflation is growing at its fastest pace in 20 years, with the cost of living increasing throughout Australia.
According to the Australian Bureau of Statistics, the annual inflation rate surpassed market estimates to 6.1% in Q2 2022 from 5.1% in Q1 2022 and 3.5% in Q4 2021. Widespread global instability paired with an increase in labour costs is impacting supply chains, which is having a detrimental impact on asset and business reinstatement / replacement values across all industries.
The current ongoing high inflation levels have continued to be guided by economic factors related to COVID-19, multiple natural disasters (i.e., bushfires and flooding), energy pressures (Eastern Seaboard), and the war in Ukraine, including increased demand, supply shortages, trade embargoes, and expansionary monetary and fiscal policy.
Insurance isn’t exempt from inflation, and movement in the market impacts tangible assets, and business interruption declared values within your insurance policies. When inflation rises, sums insured need to be monitored and adjusted to reflect the policies basis of settlement. Failure to do so can incur significant penalties for underinsurance.
Valuations are an important focus for insurers, and it is crucial that risk managers, business owners, and stakeholders understand the impact inflation has on their insurance programs and adequately declare the reinstatement/replacement values.
Table of contents
Key areas where inflation erodes the adequacy of business insurance
Inflation impacts all industries and leaves an impression on the following key risk areas:
Commercial property and contents
According to the national Cordell Construction Cost Index (CCCI), construction costs increased by 11% over the 12 months to September, exceeding the 10% annual rise recorded over the 12 months ending June 2022. Given uncertain times, there is a risk of being underinsured if a higher rebuild and associated costs are not accounted for. Should damages occur, the cost of construction, repairs, replacement, and restocking will be higher.
Plant and equipment
A rise in shipping costs, long lead times for parts, and an increase in repair and labour costs have influenced plant and equipment price increases. If business equipment is affected, insurance limits will become insufficient and inaccurate, causing increased costs to fall on your business. There is also a short supply of second-hand equipment, which applies additional pressure on companies trying to replace units.
Business vehicles and fleets
The cost associated with automotive vehicles rose 1.2% in the 2022 June quarter due to restricted global supply. With an increase in the expense of repairs and replacement vehicles, this has also led to elevated figures for specialised vehicles, parts, and accessories.
Professional liability, product liability, and directors’ and officers’
Social inflation is deemed the unknown litigation cost of unresolved cases where settlements are likely to reflect the devaluing dollar. As a result, we’ve seen increases in rates in impacted lines.
The impact of inflation on declared asset values
Due to global inflation, increased loss, and the hardening of the insurance industry, valuations have become a fundamental underwriting focus. Inflation directly impacts the values the insured must declare as part of their insurance policy. If businesses do not review their declared values regularly, this may result in inaccurate values and potential uninsured costs to a company by voiding policy terms and conditions.
“…this may result in inaccurate values and potential uninsured costs…”
Factors that affect asset values
There is no singular index that can be applied to determine what will affect asset values. Each industry and asset type are treated and impacted differently. Insurance policies respond to specific circumstances, potentially exposing companies to the risk of underestimating values.
Factoring inflation pressures into business insurance considerations provides a certain level of protection in the face of rising costs.
Inflation and underinsurance
Underinsurance is an ‘Average Clause’ outlined in commercial insurance policies. Underinsurance is commonly used in insurance policies covering buildings, equipment, contents, stock, and other property, to insure a property for ‘Replacement Value’.
In the event of a loss, insurers will apply the ‘Average Clause’ when the declared values are deemed less than the full value of the asset, and as such a claim will be reduced in proportion to the amount of the under-insurance.
It is critical for business owners to understand the impacts of an average clause within a policy and the risk to their businesses because underinsuring can cost you financially and even worse, mean the end of your business.
Underinsurance Penalty Calculation: This is considered a standardised formula as each insurance policy may contain a variation and percentage threshold allowable before the underinsurance clause applies.
“… underinsuring can cost you financially and even worse, mean the end of your business.”
How the Insurance industry is responding to inflation
As inflation costs rise, insurers face the risk of higher claims costs than predicted, which often results in them passing on those market pressures by way of increased premiums across all classes of insurance. Therefore when buying an insurance policy it is best to ensure that it will respond in the event of a claim and have the expectation of it responding to the full extent to ensure a business is not impacted.
The insurance industry is committed to an efficient, transparent claims process that is fair to policyholders. The sustainability of the insurance industry and client satisfaction is key to managing the mounting pressures of global inflation on the economy. Working with a trusted broker will ensure that insurers and clients are represented to the highest standard.
It is important to evaluate insurance policies regularly to determine financial responsibility- how much is enough to replace an asset if it needs to be rebuilt in today’s market? Would you know?
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