How exposed is your captive to inflation?

During the past two to three years, as a response to hardening commercial insurance rates, many captive owners have increased their self-retention on the property side. With more skin in the game, there is also an increased exposure to inflation and unpleasant surprises when claims arise.

It has therefore never been more important to get valuations right in order to avoid underinsurance, both from a property damage and business interruption perspective. Captive owners set retentions based on their management’s desired risk appetite, but if all the company’s assets are undervalued, the exposures are materially higher than anticipated.

Multinational insurance buyers know how challenging it can be to appraise property portfolios and how this is typically a source of delay and complexity in finalising a global programme. Add to that the complications presented by runaway inflation, more skin in the game and supply chain uncertainty, and suddenly risk and insurance managers are facing an increasingly complicated renewal process.

Avoiding underinsurance
To ease the renewal process and avoid underinsurance, it is important to start discussions early and ensure valuations are as up to date as possible. Property insurance valuation experts in the UK found that as many as 77% of the properties they surveyed were underinsured by as much as 45%(i). The research took place before the supply chain crisis further impacted rebuild and machinery replacement costs, and extended the time taken by many businesses to reinstate their properties after a loss event. Also, significant swings in the value of many of the world’s currencies have impacted the cost of imported building materials and machinery, inflation in many countries has increased the cost of labour and many industries project post-pandemic revenue recovery. Combined, all these factors suggest that the level of underinsurance is now even higher.

Even the experts have been taken aback by the rate of inflation in certain jurisdictions. with the Organisation for Economic Co-operation and Development’s forecasts(ii), for instance, proving to be understated. During the last 12 months, all items in the US Consumer Price Index increased by 7.7%, with the indexes for shelter, motor vehicles and new vehicles, insurance, recreation and personal care among those that increased in October’s figures(iii).

What does this mean for captive owners? Put simply, companies with self-insurance vehicles are facing all the same pressures as commercial insurance companies, particularly those with captive insurers. While a cumbersome task, it is essential that assets are accurately valued and indexed, given the impact inflation has already had during the past 12 months. While initially anticipated to be a short-term challenge at the start of 2022, central banks agree we are now facing the prospect of a more prolonged inflationary period through 2023.

With the right values, the right premiums for the captive retention can be set and reserve buffers can be adjusted, loss estimates can be correctly calibrated and limits reviewed. And on the business interruption side, risk managers can prepare for extended lead times and any delays and additional costs associated with claims inflation, by – for instance – extending indemnity periods.

Don’t forget business interruption
Industry sources predict claims inflation is expected to extend the hard market(iv) as complex claims, including accidents and natural catastrophes, become more expensive to remediate. So far in 2022, costly examples of extreme weather have been seen around the world, including winter storms in Europe, very large flood losses in Australia and South Africa, typhoons in Japan and the Philippines, windstorm events in the US and the Caribbean, an earthquake in Mexico and droughts in South America. The insurance industry paid out $35bn in the first half of the year in natural peril claims, according to Swiss Re sigma(v) and there have been a number of cat events that have occurred since that publication date, including hurricane Ian, substantially inflating this figure.

The ongoing supply chain crisis, exacerbated by country lockdowns, labour shortages, rising energy costs and the ever-changing geopolitical landscape among other things, is impacting property repair and reinstatement to an extent not experienced in recent history.

As the cost and availability of raw materials and skilled labour come under pressure, building repair costs become more expensive, which can significantly delay the completion of work. And the more the restoration timeframe slips, the greater the implication from a business interruption point of view. Gallagher notes it is seeing interruption periods increase due to backlogs in planning approvals, before repair and reinstatement of damaged buildings can even begin(vi).

Another implication for captive owners is that their property retentions could increase as a result of prevailing headwinds. Hard market pressures could further add to the appeal of self-insurance, with captives continuing to be used to insure more risk. While it might seem obvious, the more a captive is utilised to take on the parent company’s own property risk, the more exposed it is to a range of inflationary issues that can compromise returns, unless these are properly anticipated.

Seek the support of your broker
Corporate risk and insurance managers (and their CFOs) are not going it alone. We encourage all insurance buyers to engage with their brokers and make the most of the tripartite relationship to ensure the impact of inflation is fully considered ahead of the upcoming renewal period. For captive owners, with skin in the game, it can empower them to adjust captive premium, increase reserve buffers or appropriately transfer more risk to the reinsurance market, either directly or via a fronting carrier.

Now is the time for intermediaries to shine, as they advise their clients on how best to navigate this new landscape and work transparently with underwriters to ensure coverage is fit for purpose. Brokers are integral to ensuring that valuations are carried out so that sums insured are as accurate as possible so that if the worst happens, clients are fully indemnified and positioned to recover from a loss as quickly as possible.

Contributed by Alastair Bigg, global head of multinational – property and energy, AIG, and Stephen Morton, head of complex multinational solutions, AIG

(i) Barrett Corp & Harrington found 77% of the properties they surveyed were underinsured by 45%

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