Risk of underinsurance grows for commercial buyers as inflation bites

With rising inflation and a hard market, commercial insurance buyers face the growing risk of underinsurance and should get timely and accurate replacement valuations to help combat this threat, Harminder Chana, director of valuation and analytics at John Foord, an independent valuation company, told Commercial Risk.

The combination of Covid-19 and the war in Ukraine has created huge volatility in commodity markets, and the prospect of a prolonged period of high inflation. Ratings agency Fitch predicted that US inflation will average 7% this year and peak at 9%, while eurozone inflation will average 5%. The price of oil is now trading at about $100 per barrel and global commodity prices recorded their sharpest ever weekly rise following Russia’s invasion of Ukraine, reaching their highest levels since 2008.

Even before the war in Ukraine, the pandemic had caused inflation to rise in Europe and the US to levels not seen for almost 40 years. As the immediate threat of Covid-19 eased, consumer demand surged, triggering higher energy prices, increased shipping costs and price hikes for certain raw materials.

Price volatility for some materials has been unprecedented and led to some projects being delayed, cancelled or re-tendered, while companies have seen profits disappear, said Chana.

A wide range of materials and products have increased in value during the past year, including construction materials, electronics, precious metals and renewables. Steel price increases have ranged between 35% and 50%, while the price of copper has increased by 20%, with some spikes of more than 60%, according to John Foord analysis.

Rising prices and higher inflation mean that insurance buyers and insurers need to pay closer attention to replacement values, according to Chana. Even before the war in Ukraine, John Foord analysis predicted a 12% to 17% global hike in replacement values in 2022. In the UK, construction material prices are expected to continue to increase by more than 16%, while in Germany rises are expected to be more than 14%.

“The next 12 months will see replacement values continue to rise to varying degrees. Covid-19 restrictions are still in place in parts of Asia, while there are skill shortages in the US and UK. The conflict between Russia and Ukraine just adds to the problem and effects vary in different jurisdictions,” said Chana.

Following the outbreak of war in Ukraine, the rise in inflation may now be more prolonged than was predicted at the start of the year. “It is very difficult to say with any real certainty what the exact impact of Russia’s invasion of Ukraine will have on overall costs, however it is clear that there will be a lot of knock-on consequences on the global sourcing of energy, commodities and even labour over the medium to long-term, as a new political reality dawns. The only way to really keep on top of developments is to track a large number of data points, market volatility and limitations, which is what we do at John Foord,” said Chana.

Exchange rate volatility also feeds into replacement values. For example, sanctions caused a 40% plunge in the value of the Russian ruble, while the value of the Turkish lira has halved since March 2021. Assessing cost increases in countries of origin before factoring in exchange rates is fundamental to accurate valuations, said Chana.

Rising prices and inaccurate valuations mean that policyholders may unwittingly be underinsured, he continued. Analysis by John Foord during the fourth quarter of 2021 revealed underinsurance of more than $10bn across a portfolio of power generation and property assets.

“The risks of underinsurance are going up. It is important to have a regular and accurate understanding of replacement values, to ensure you are adequately covered and to inform insurance buying. Independent assessment will be key,” said Chana.

Many companies buy insurance based on their own internal valuations and use accounting methodology to estimate values, rather than replacement values, explained Chana. Net book values are typically discounted calculations from the original costs and are not a true reflection of the cost to reinstate lost or damaged property at the time of the loss, he said. Replacement valuations can also take into account other factors, like ESG considerations or more efficient technology, when calculating replacement costs, he added.

Accurate assessments of replacement valuations are particularly important in a hard insurance market, said Chana. Out-of-date or net-asset valuations can result in both underinsurance and overinsurance. In contrast, regular and accurate replacement value assessments will help risk managers make informed purchasing decisions and better understand insurers’ pricing, he said.

Earlier this year, John Foord launched an online asset valuation tool that enables risk managers and insurers to monitor replacement and asset values in real time. Initially launched for the power generation and buildings sector, more industries will be added to the platform during the next 18 months.

The cloud-based platform uses artificial intelligence to provide accurate real-time replacement and valuation costs for commercial and industrial fixed assets. The information is constantly validated and augmented with external data sources, including commodity and labour pricing, and ongoing valuation research.