Rising inflation and the risk of underinsurance

In July 2022, UK inflation hit a 40-year high of 9.4% and is widely expected to creep higher. The reasons for this rapid rise are both complex yet familiar: the war in Ukraine, rising post-pandemic demand, fluctuating exchange rates, labour shortages, and intense competition for resources from rapidly developing economies such as China. These factors and more are combining as a catalyst for the fast-rising inflation we’re experiencing for the first time in decades.

While inflation is pushing costs up, there is a flipside. Rising costs mean that many business’s assets have a significantly higher value, and replacement cost, than a few months – or even weeks – ago. This has led many businesses to unintentionally risk being underinsured.

Why is inflation leading to underinsurance?

First, let’s take a look at what underinsurance actually means. In a nutshell, being underinsured means that the sum insured on your policy won’t cover the cost of repairing, replacing, or rebuilding the cost of an asset. Whether that be the cost of rebuilding your premises or replacing all of your stock, if you make a claim and find you’re underinsured you could be liable for covering the shortfall.

Rising inflation is leading to underinsurance of different assets across different industries. Typically, a policy holder will have taken out a policy a number of months ago. As inflation has spiralled, the cost of repairing, replacing, or rebuilding those assets has increased significantly, leaving a gap between the sum insured and the current replacement cost. These are a few examples:

• Fuel stock. The rising cost of fuel has meant that the replacement value of fuel stocks is rising as well. Inflationary pressures have also made theft more likely, as have restrictions on red diesel use.
• Materials. As the cost of materials such as timber, copper, steel and precious metals have risen, existing stocks have also increased in value – often outstripping the amount for which they’re insured.
• Repair and replacement costs. The cost of repairing or replacing assets such as buildings, plant, and even fertiliser have spiralled. Re-building costs have not only been pushed up by increased material costs, but also by higher labour costs. It’s important to remember that the sum insured on your building insurance should be the rebuild value, not the market value.
• Foreign currency costs. Many currencies are currently very volatile. This can mean that the cost of replacing or repairing imported assets can fluctuate almost daily.
• Stocks sum insured. The current value of any stock you’ve got, as well as the replacement cost, is likely to have risen since it was first purchased. Your sum insured should account for the current replacement value, and take into account seasonal fluctuations when you may have more stock than other times of the year.

How many UK businesses are underinsured?

Even before the inflationary crisis, large numbers of businesses were already underinsured. Industry estimates based on reports from sources such as The Building Cost Information Service (BCIS), Chartered Institute of Loss Adjusters (CILA) and Financial Conduct Authority (FCA) suggest that half of all UK businesses are underinsured. Furthermore, across a range of policies, these firms are underinsured by an average amount in the region of 50%.

Factoring in the pressures caused by rapid inflation, this figure is now likely to be significantly higher.

How can I minimise the risk of being underinsured?

There are many practical steps you can take to avoid being underinsured. These include:

• Mid-term valuations. Many businesses are in the habit of arranging annual valuations for insurance purposes. At a time of rising prices, it’s wise to organise a mid-term valuation to assess increased costs of replacing, repairing, or rebuilding an asset. This will allow you to increase your cover via your broker if necessary.
• Re-assess property rebuild costs. The soaring costs of labour and materials mean that policies with property rebuild costs will almost certainly need revisiting. Get buildings independently valued by a RICS surveyor so you can ensure your policy covers you for increased rebuild costs.
• Audit assets that are likely to have increased in value. Machinery, plant, fuel, fertiliser, stocks, and materials are likely to have increased in value. Audit all of your business’s assets and make sure valuations are up to date.
• Your Business Interruption Insurance indemnity period. If your business was unexpectedly unable to operate it’s likely that currently it would take longer to reinstate your business to the position it was in before the loss occurred. It would be wise to reassess whether your indemnity period is long enough.

What help is available?

If you are concerned that your business may be underinsured, it’s a good idea to maintain a dialogue with your insurance broker. As your broker, we are always on hand to help you review the sums for which you’re insured. You can contact us on 01603 218000 for further assistance.