Author: Damien Eccleton
Businesses are often surprised to discover their Property insurance policy doesn't cover the full value of their assets. As a result, when the unexpected strikes, they must pay the difference between their claim payout and the actual cost to repair or rebuild their property.
In recent years, Property insurance buyers have navigated a challenging market, marked by inflation, rising material costs and increased claims, which limited capacity from insurers and reinsurers. However, the market has now softened with more capacity available to meet the growing demand for coverage.
As insured values increase, inflation and more frequent and severe claims are affecting restoration times and overall loss costs. Underinsurance can result in substantial out-of-pocket costs for repairs or rebuilding commercial properties after a loss. Reviewing insurance-to-value (ITV) calculations will be critical in 2025 and beyond to help organizations avoid these expenses.
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Navigating inflation and rising costs
Inflation is a growing concern, mainly due to labour and supply issues from the pandemic, worsened by political uncertainty:
Labour shortages. The past year has seen labour shortages in nearly all sectors for various reasons. Primarily, the impact of the pandemic has caused many younger workers to reevaluate their employment priorities, and baby boomers are now retiring. These labour shortages have led to substantial struggles for the construction businesses, often causing project delays and increased salaries to retain or attract workers, driving up labour costs and sparking inflation concerns.
Supply chain disruptions. Since the beginning of the year, supply chain disruptions have occurred primarily due to political uncertainty, leading to increased demand for various items and materials amid a slowdown in production and increased cost of resources. Consumer demand has outpaced inventory, as more consumers make large purchases to avoid price hikes. Consequently, costs across industries have soared, further contributing to inflation. Business owners must understand inflationary factors and ensure adequate coverage during these challenging market conditions.
The rising Consumer Price Index (CPI) demonstrates the impact: Statistics Canada notes a 2.3% year-over-year increase in consumer prices, slightly down from February's 2.6% rise.*
Inflation could pose several challenges in the commercial insurance market, impacting both insurers and policyholders.
Strategies for securing adequate coverage
Due to ongoing inflation issues potentially leading to higher premium costs, coverage restrictions and underinsurance concerns, policyholders must take proactive steps to minimize these complications.
The current headwinds require a holistic and innovative response. Tools such as risk engineering, up-to-date valuation replacement cost appraisals, increased risk retention and alternative risk transfer solutions are now available. While large corporations were once the main users of these strategies, midmarket companies are increasingly adopting them due to their growing sophistication in purchasing.
These strategies include:
Risk engineering. Implementing robust risk management practices can help mitigate potential losses and improve the insurability of a property. By identifying and addressing vulnerabilities, businesses can reduce their risk profile and potentially secure better coverage terms.
Replacement cost appraisals. Regularly conducting ITV replacement cost valuation appraisals ensures that insured values accurately reflect current market conditions. This practice helps prevent underinsurance and ensures that coverage limits are sufficient to cover potential losses.
Increased risk retention. Some businesses may choose to retain a higher level of risk, opting for higher deductibles or self-insurance for certain exposures. This approach can lead to cost savings on premiums while still providing adequate protection against catastrophic losses.
Alternative risk transfer solutions. These solutions offer additional protection and flexibility in managing risk.
- Captives allow clients to establish and manage their own insurance entities, offering customized coverage and risk retention for greater control and potential cost savings.
- Parametric insurance provides swift payouts based on predefined parameters, such as weather events, enhancing flexibility in managing unpredictable risks.
The impact of inadequate program limits
Business asset values fluctuate over time due to growth, upgrades, acquisitions and macroeconomic factors like inflation. This fluctuation can lead to underinsurance, where your coverage doesn't match the current replacement cost of your assets. Insurance payouts are typically based on replacement costs. Underinsurance happens when assets are insured for less than their replacement cost (Scheduled Limit Policy) or when losses surpass the single limit during the policy period (Limit of Loss Policy).
- A Scheduled Limit Policy offers specific coverage for individual items or locations, each with its own limit, ensuring high-value assets are protected. It requires detailed listings and regular updates, making it ideal for businesses with varied asset values.
- Conversely, a Limit of Loss Policy provides aggregate coverage with a single limit for all properties or losses, simplifying management without detailed listings. However, careful consideration of the overall limit is crucial to ensure adequate protection, especially for high-value items.
Commercial insurance policies use the declared value of your assets to calculate premiums. If the declared value is less than the current value, a co-insurance clause on a policy may reduce the payout for a loss. This clause protects insurers from intentional undervaluation by clients. It results in a reduced claim payment based on the difference between the declared and actual values. Likewise, a margin clause could be used to limit the insurers liability above a declared value.
| Co-insurance Clause | Margin Clause | |
| Purpose |
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| Functionality | An insured who fails to meet the co-insurance requirement may face a penalty in the form of reduced claim payments. For example, if the property is insured for less than the required percentage, the insurer only pays a proportionate amount of the loss. | Insurer pays up to a certain percentage above the declared value, but not more than that margin. For example, if the margin is 10% and the declared value is $1 million, the insurer covers up to $1.1 million. |
| Benefit | Encourages policyholders to insure property to its full value, reducing the risk of underinsurance. | Protects the insured from underinsurance due to minor valuation errors or unexpected increases in property value |
| Key differences |
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Could your business afford to cover the shortfall if the unexpected strikes?
| Declared Value | $1,650,000 |
| Current Value | $3,000,000 |
| Co-insurance Provision | 80% |
| Loss Amount | $1,500,000 |
| Claim Payout | $1,320,000 |
| Shortfall of $180,000 |
Underinsurance in action: Commercial property
The operation of the co-insurance clause is demonstrated for a commercial property in the following claim example of a regional shopping centre with a declared value of $1.65M that was severely damaged by fire. An insurer investigated the claim and valued the shopping centre at $3M with a replacement estimate of $1.5M to repair the fire damage. The insurer applied the co-insurance clause under the terms of the client's policy. In this example, the property owner paid a significant amount out of pocket with underinsurance of $180,000.
The importance of detailed risk information
The best way to avoid underinsurance is to get a professional insurance valuation of your business property and assets. These reports estimate the actual cost to rebuild or replace an asset at current value, ensuring adequate insured values for your property.
Not all valuations are created equal. When there's outstanding finance on a property, bank or finance provider may obtain a valuation. However, this type of valuation is more concerned with the market value of the property in the event of a forced sale, rather than the replacement value from an insurance perspective. For insurance, valuations should reflect the cost to restore the property to its pre-claim condition.
Rising property values can shift properties into new risk categories, potentially requiring businesses to enhance security or fire protection measures, for example. These changes might not align with the current insurer's risk appetite. Therefore, it's crucial to conduct valuations well in advance of renewals.
Conclusion
In an increasingly challenging insurance market, securing adequate program limits is crucial for protecting businesses against underinsurance. By adopting a holistic approach and leveraging strategies like risk engineering, valuation appraisals, increased risk retention and alternative risk transfer solutions, insurance buyers can navigate the complexities of the current climate. Detailed risk information and proactive management are key to achieving favorable renewal outcomes, ensuring businesses are protected against rising costs and inflation.
