How inflation causes inadequate business insurance coverage

Events in the past years, such as the Ukraine-Russia war, interest rate hikes, energy price shocks, geopolitical sanctions, and supply chain disruptions, exerted upward cost pressures on Asia’s businesses. The impact of higher commodity prices, borrowing costs, and wages is being felt across industries, especially in construction, real estate, and logistics.

Inflation also leads to higher costs in business recovery, such as reinstating property, plant, and machinery in the event of a severe loss. Additionally, insurers are now demanding accurate asset valuations and business interruption calculations, and are querying reported values amidst rising natural catastrophe losses and reinstatement costs.

In response, businesses need to take a proactive approach in keeping their asset valuations and business interruption (BI) declared values up-to-date and accurate to ensure adequate property damage and business interruption (PDBI) coverage at fair premium rates. Failure to do so can lead to underinsurance, resulting in uninsured losses.

Furthermore, the application of the average clause within the PDBI insurance policy may allow the insurer to reduce the pay-out by the same proportion as the asset is underinsured. It is a costly consequence which has, in many cases, made it difficult or even impossible for companies to recover.

Why accurate declared values are important for business recovery

Risk managers and business leaders need to be mindful that apart from inflationary impact on construction costs such as building materials and labour, the following evaluation methods also affect asset declared values and may result in underinsurance:

Using market or book value instead of replacement costs.
Using last year's declared values or simply increasing values by a percentage.
Declaring the value of what you would prefer to replace the asset with.

Conversely, inaccurate declared values can also lead to overinsurance and excess expenditure on business insurance coverage.

Case study #1: A real estate company with assets across Asia

A Marsh client with 30 owned locations in the Asia region previously had different valuation methodologies for each location and had difficulties determining the correct methodology to use to substantiate the values across their portfolio.

Marsh valuation specialists helped appraise the properties and found that 23 of the properties were underinsured, leading to a potential total exposure of S$382.6 million. It was also identified that several of their largest properties were significantly underinsured below 50%, which represented a high-risk scenario. The Marsh team also found three properties over-insured by up to 293%.

Subsequently, with the help of Marsh, the client updated their sums insured and ensured optimised coverage.

Accurate declared values for asset valuation ensures adequate cover for property damage. For business interruption, accurate declared values support businesses in returning to the financial condition they would have been in following an insured loss event.

The importance of an accurate maximum indemnity period

The indemnity period required for business recovery, which can be easily overlooked, is also a crucial consideration in assessing BI declared values. Companies need to be aware of evolving changes in inflation, supply chain disruptions, labour and material shortage that can impact the period needed for business recovery.

Hence, it is important to regularly review your BI declared values with forensics accountants who can help you determine the accurate maximum indemnity period and assign appropriate values to your business insurance.

Case study #2: A technology sector client in Taiwan

A Marsh technology client was concerned about their inability to recover from a major loss within the maximum indemnity period in their existing policy. In response, Marsh forensic accountants developed a financial model to assess the client’s appropriate BI declared value and facilitated a workshop with the relevant stakeholders in the company to assess their maximum foreseeable loss by:

Establishing three potential worst case scenarios,
Developing a detailed chart to simulate their recovery from these scenarios, leveraging Marsh’s significant claims experience, and
Concluding on the likely maximum period for recovering the business, considering physical assets, production capacity, and sales forecast.

Our engagement allowed the client to fully appreciate their potential exposure period and recommended an update of their maximum indemnity period from 12 to 24 months, potentially avoiding uninsured losses of over US$100 million.

Assess the impact of inflation on your business insurance coverage today

Has inflation or other factors left you underinsured? Consider these questions:

How were your asset and business interruption declared values determined?
When was the last time you conducted valuation for your assets?
How much is enough to replace your lost assets at today’s market value?
Is the current maximum indemnity period sufficient for business recovery?

To safeguard your organisation and assets from potentially financially debilitating losses, fill in the form below to speak to a Marsh representative today.