In the current economic climate, we’re all seeing inflation eat away at our finances. In January 2023, the Consumer Price Index (CPI) inflation rate stood at just over 10% – a far cry from the 0.7% we experienced two years earlier.
However, while there are the obvious effects of inflation, there’s another that businesses need to take into account: claims cost inflation. This is an increase in the amount it costs an insurer to settle a claim. For many types of claims, this increase can be significantly higher than standard measures of inflation.
A good example of this would be a claim on your commercial property insurance. A claim for a total or partial rebuild of a commercial property today would cost significantly more than a year ago. This is simply because not only has the cost of construction materials risen by 25% in the last year but labour and transport costs have also shot up.
In this article, we look at why it’s more important than ever for businesses to keep an eye on the effect inflation could have if they made a claim and what they can do now to minimise its potential impact.
- What is driving the big increase in claims cost inflation?
- What is the impact of claims cost inflation on businesses?
- What can I do to mitigate the effect of claims cost inflation?
Over the last few years, a range of unexpected factors have combined to drive up materials, labour and logistics costs. Some have also resulted in an increased number of insurance claims, making it more expensive to process and settle them. These factors include:
- Brexit. This has resulted in a shortage of skilled labour, particularly in industries such as construction (before Brexit, 9% of construction workers were EU nationals) which, in turn, has pushed up labour costs. Stricter border controls have increased import and logistics costs, as well as delayed supply of parts and materials, leading to longer waiting times for repairs.
- War in Ukraine. This has led to fewer materials (such as timber) being available. In addition, the knock-on effect of high energy and fuel prices has increased the cost of transport and distribution, contributing to the increased cost of reinstating, repairing, or replacing damaged items.
- Shortage of semiconductor chips. Loss of production due to the Covid-19 pandemic, and a major fire at one of the car industry’s biggest suppliers, negatively impacted the supply chain of many manufacturers, leading to significant cost increases and delays.
- Covid-19. The pandemic saw an increase in negligence claims against employers, while delays to medical assessments meant claims took longer to complete. The supply of raw materials came under pressure as DIY projects during lockdown increased, which spiked further as restrictions eased, making them more expensive.
- An increase in fraudulent claims. In tough economic times, fraudulent claims (especially for injury) increase, pushing up insurers’ costs.
- Climate change. An increase in extreme weather events has led to an increase in volume and severity of claims, particularly due to flash flooding and storms.
- Modern building materials. Large fire losses due to cladding and modern building materials have increased the average costs for an insurer.
- Care costs. It now costs more to provide ongoing care for people after an accident, pushing up the cost of personal injury settlements.
Claims cost inflation can have multiple impacts on businesses. Below are four key factors that you should bear in mind.
Impact 1: increased premiums
The most obvious effect is that the premium you pay at renewal may increase. Your broker will work with you to help calculate the right level of cover, but premium increases will vary depending on the type of insurance you have.
For example, premiums for insuring your machinery, plant, stock, and technology equipment will consider the increased lead times and current prices for replacement items, while premiums for commercial property will consider the increased cost of rebuilding the premises.
Impact 2: underinsurance
Claims cost inflation also means you need to be vigilant about business underinsurance. The rising cost of settling a claim means there can be an increasing difference between the sum insured and the cost of repairing or replacing the insured item. To avoid this, businesses need to ensure that buildings and assets are insured at their rebuild or replacement value, not their market value.
Impact 3: the ‘average clause’
Underinsured assets can cause major issues, particularly if a claim falls foul of the ‘average clause’.
For example, if a commercial building has a rebuild value of £400,000 based on current material and labour costs but has a sum insured of £200,000, it is underinsured by 50%. If a claim is made for £50,000, under the terms of the average clause, the insurance company may only settle 50% of the claim. In this case, £25,000, leaving you to cover the shortfall.
Fortunately, most commercial insurance policies include an 85% condition of average clause which allows for a margin of error. If, at the time of the loss, the sum insured represents 85% or higher of the reinstatement value, the average clause will not normally apply. However, this does underline the importance of getting property revalued for insurance purposes on a regular basis – especially in periods of high inflation.
Impact 4: claims can take longer to settle
Unfortunately, claims can also take longer to settle. The reasons for this depend on the type of claim you’ve made, but examples could include the following:
- A shortage of vehicles and parts. Shortages and higher prices can lead to some vehicles being repaired when they would previously have been written off. However, this can take longer due to shortages of parts and delays in sourcing or importing them.
- Delays in medical assessments. There are still backlogs from the COVID-19 pandemic, meaning injury claims can take longer to assess and settle.
- Legal delays. The pandemic worsened an already large backlog of cases in the court system, and, despite efforts by the government, this still leads to delays in insurance claims being settled where there is a legal dispute.
While claims cost inflation can’t be avoided in the current economic climate, there are steps businesses can take to mitigate some of the problems it causes. Our recommendations include the following:
- Let your broker/insurer know about claims quickly. The sooner they know you intend to make a claim (or if you think a claim is likely to be made against you), the more likely it is they’ll be able to control costs by involving Insurers and Loss Adjusters at an early stage. Provide them with as much evidence as you can to make the claims process as smooth as possible.
- Review your sum insured regularly. While the cost of materials such as oil, gas, metals, fertiliser, and timber continue to rise, consider a mid-term valuation to ensure your insurance cover is still adequate. Similarly, if you make new purchases or changes to buildings, update your insurance values to cover these.
- Review your indemnity period. If you have business interruption insurance, it’s wise to review your indemnity period and check it is still sufficient to get your business back to the same position as the day before a loss occurred. Many firms have a 12-month indemnity period, but given the increased likelihood of things like machinery delays and shortages of materials, it may take significantly longer to get your business back on its feet. Therefore, it may be better to increase your indemnity period – many insurers allow you to extend it by six month increments up to 24 or 36 months.
- Invest in risk management and health and safety training. This will lower your risk of a claim and make you a more attractive risk to insurers, giving your broker more options at renewal.
- Review gaps in cover. It can be tempting to cancel policies to bring costs down, but this will leave you exposed and liable for the costs yourself if you need to claim. It’s also worth checking that there aren’t areas for which you don’t currently have insurance but should.
- Review your supply chains. Given the fragility of some supply chains at the moment, it’s worth considering whether you can diversify to spread the risk. Also, make sure you have factored in price increases into your business continuity plans.
Claims cost inflation can result in additional risks for your business, especially if you inadvertently end up being underinsured. We strongly recommend keeping a close eye on the rebuild and replacement value of your assets and whether your insurance policies still provide an adequate level of cover. If you’re unsure, speak to your broker or contact us at 01603 218000.