Written by: Griffiths & Armour on: 23 Sep 2022
DANGER – Inflation and Underinsurance
News headlines have been dominated for months by the self-proclaimed “Cost of Living Crisis” following the sustained rise in inflation in the UK to over 10%, which is the highest level for over 40 years. The reasons for this are varied and include the release of pent-up demand following the Covid-19 Pandemic with associated supply chain difficulties, labour shortages and steeply rising energy prices triggered by the War in Ukraine. Whatever the cause and whichever indices is consulted, the result is surging increases in the price of energy, foodstuffs, fuel and materials.
Insurance implications of Inflation
As a result of these significant inflationary pressures, all businesses, organisations and institutions must continually review the basis and adequacy of their Buildings, Contents and Stock sums insured. For the cost of reinstating Buildings or replacing Contents, Machinery and Stock; this will have increased very significantly over the previous 12 months and this must be reflected in the declared values and sums insured for your policy renewal.
There are a plethora of inflation indices available including the Retail Price Index (RPI), the Consumer Price Index (CPI), the various Buildings Cost Information Service (BCIS) Indices or the BEAMA Cost Index to name but four. The primary advice, is always that any Building declared value should be based on a recent Buildings Reinstatement Valuation completed by an expert Valuer. Ideally such valuations should be completed every 3 years and certainly at least every 5 years.
If you have not had such a valuation within the last 5 years, then we would strongly recommend that such a reinstatement valuation is commissioned and completed prior to your next insurance renewal and from which your Buildings declared value can be identified and used for renewal purposes. Inflationary increases should then be applied at each future renewal, until the next valuation, based on the Valuers or your Insurer’s recommended indexation. Contents, Machinery and Equipment valuations should also be reviewed and determined as the cost of replacing all such items on a new-for-old or indemnity basis.
As a guide, a leading Insurer, Aviva are currently recommending the following indexation increases are applied to current declared values for any renewals due to be completed in November 2022:
- Commercial Buildings – 12.3%
- Commercial Contents – 14.3%
Underinsurance and the Average Clause
Please be aware that the consequences of not submitting adequate and suitable declared values can be severe and prohibitive. If the sums insured are inadequate in the event of a total loss of a Building and its Contents, then the insurance indemnity will not provide the full funds required to reinstate the Building, nor replace its Contents and Equipment. The shortfall could be a significant financial liability, falling on the business or organisation to pay for. This scenario is termed underinsurance and most Property insurance policies have an Average Clause which further penalises policyholders in the event of underinsurance.
In simple terms, the Average Clause states that the policyholder will themselves be responsible for an element of any claim and loss, if underinsurance applies (i.e. if on review during the claims process, the sums insured were discovered to be inadequate to cover the full cost of reinstating the building and replacing its contents as new). This element mirrors the level of underinsurance, therefore if the review identified underinsurance of 20% applied, then the value of the claims pay-out would be reduced by 20% accordingly (i.e. a £1 million claim would only be paid at a value of £800,000). This makes it imperative that sums insured are always suitable and a true reflection of the reinstatement or replacement cost.
Day One Reinstatement Clause
Finally, given the current level of inflation in the UK, the declared value at the start of any 12 month policy period could clearly be inadequate before the end of the annual policy and even more inadequate to cover the period of reinstatement of a Building after a major fire (which could potentially take years to include obtaining planning permissions, sourcing contractors to undertake the works and any “lead-in” times to source complex machinery or equipment). To reflect and guard against this, most Property insurance policies have a Day One Reinstatement clause under which the Insurer agrees to apply an inflationary uplift (e.g. usually a factor of 15%) to the values declared by the policyholder. This means that the actual sums insured under the policy are in this example, actually 15% above those declared by the policyholder and which in normal times, should adequately protect against underinsurance occurring due to inflation pressures during the period of the policy or reinstatement. For a Day One basis to operate correctly, your declared valuations need to be accurate on date of renewal – it is not to be seen as a buffer for incorrect values.
However, in the current economic times, it is now feared that a 15% factor is inadequate, particularly in the event of a prolonged period of reinstatement, for example following a catastrophic loss or damage to a Listed Building requiring various consents to rebuild. As such, an increase in the Day One Reinstatement factor from 15% to a higher value should be considered at renewal, for example to a factor of at least 25% or perhaps even higher, if a portfolio includes Listed Buildings. Insurers are becoming more flexible to increase this percentage amount, but it is not automatic and does require negotiation.
If you have any questions about the contents of this article or general queries, please click below to submit your enquiry to Griffiths & Armour Client Services Executive, Rhydian Thomas who will be happy to help.