Covering Costs: ITV, Inflation, and Insurance in a Changing Landscape

May 30, 2024

In recent years, the insurance landscape has been reshaped by a convergence of unprecedented challenges, ranging from catastrophic natural disasters like hurricanes and wildfires to the unparalleled disruptions induced by the COVID-19 pandemic. These events have left an indelible mark on the economic terrain, particularly evident in the soaring building costs and supply chain disruptions plaguing the property insurance sector. This article seeks to unravel the intricate relationship between Insurance to Value (ITV), inflation, and escalating building costs, shedding light on their profound implications for both policyholders and the broader insurance industry.

The Impact of Rising Building Costs

The year 2020 witnessed an extraordinary sequence of 63 catastrophic events, ranging from Midwestern tornadoes to Western wildfires and Southeastern hurricanes, intensifying the challenges posed by the COVID-19 pandemic. As communities and businesses sought to rebuild, the demand for labor and building materials surged, triggering significant increases in costs.

Fast forward to 2023, global insured losses hit $123 billion, marking a record-setting year for catastrophic events. According to reports from Aon and Gallagher Re, severe convective storms (SCS) represented almost 58% of these losses globally. In the United States, six out of the ten most expensive events were attributed to SCS events, further underscoring the escalating frequency and severity of natural disasters. And since January 2020, national reconstruction costs have risen by an average of 8.1%, with material costs experiencing a 5.2% increase on average. Lumber prices, in particular, have soared by a staggering 85% in certain regions, exacerbating the financial strain on businesses and the urgent need for robust risk management strategies to mitigate the impact of future catastrophes.

What is ‘Insurance to Value’?

Insurance to Value (ITV) is a fundamental concept in risk management, representing the ratio of the insurance coverage amount to the actual value of the asset being insured. In the context of property insurance, if the insured value is less than the actual value of the property, it results in an incomplete Insurance to Value ratio. Inadequate ITV can leave policyholders exposed to substantial financial loss in the event of a claim, underscoring the importance of regularly reassessing coverage to align with the true value of assets.

The Implications of ITV

Inflation has also had a profound impact. Nonresidential construction costs continue to remain high with a 37% increase over the past four years. 65% increase in fabricated structural steel. 37% increase in the price of concrete products. Machinery and equipment costs have increased 22% over the same period. And as the cost-of-living rises, so does the value of assets; failure to adjust insurance coverage in response to inflation can result in inaccurate ITV ratios, leaving policyholders underinsured. For instance, if the value of real property or equipment appreciates due to inflation and insurance coverage remains static, the ITV ratio declines, potentially leading to financial vulnerability in the face of unforeseen events.

Understanding the implications of rising building costs on Insurance to Value (ITV) is crucial to ensuring appropriate coverage in the event of a loss. Delays in post-loss recovery due to skilled labor shortages and expensive materials may expose businesses to exceeding policy limitations, with prolonged recovery times potentially surpassing the period of indemnity. But the consequences of an inaccurate or artificially low ITV extend beyond immediate cost savings; underreported values can lead to underinsurance or trigger coinsurance penalties. Notably, an inaccurate ITV is a primary cause of property claim litigation, as policyholders may find themselves inadequately covered in the event of a total loss.

Strategic Imperatives

Amidst the complexity of inflationary pressures and volatile market conditions, insurance agents play a pivotal role in guiding policyholders through the intricacies of ITV calculations. Here are some strategic imperatives for agencies to consider:

  • Proactive Client Engagement: Think about initiating mid-term meetings to educate policyholders about the implications of rising building costs and the importance of maintaining adequate coverage. By fostering open communication and providing insights into market dynamics, agents can empower clients to make informed decisions about their insurance needs.
  • Precision in Rebuilding Cost Estimates: Be sure to conduct thorough reassessments of buildings, contents, and equipment replacement cost estimates to ensure alignment with current market trends. By staying abreast of supply chain disruptions and labor shortages, you can anticipate potential delays and cost fluctuations, thereby mitigating policyholder risks.
  • Contingency Planning for Supply Chain Disruptions: Given the prolonged impact of supply chain disruptions, work with policyholders to develop robust contingency plans for sourcing and procurement. Diversifying supply chain networks and exploring alternative sourcing options can also help mitigate the impact of disruptions on reconstruction efforts. And, considering the extended timelines for recovery due to supply chain disruptions, it’s also essential to factor in these delays when calculating business income. By accurately assessing the potential impact of prolonged recovery periods on cash flow, you can make informed decisions and ensure your continuity even in the face of unforeseen challenges.
  • Vigilance in Policy Review and Revision: Collaborate closely with policyholders including comprehensive reviews of policy limits and sub-limits to ensure adequate coverage. By advocating for policy terms that reflect the true replacement costs of assets, you can safeguard businesses against the risks of underinsurance and coinsurance penalties.

Looking Ahead

In a landscape marked by inflation, rising building costs, and frequent catastrophic events, policyholders, insurers, and agents must collaborate to navigate the complexities of Insurance to Value, ensuring that coverage remains commensurate with the evolving value of assets.

By addressing these challenges head-on, the industry can adapt to the changing landscape and continue to provide robust protection for individuals and businesses alike. Fostering proactive client engagement, precision in rebuilding cost estimates, and vigilance in policy review are essential strategies for agents navigating the shifting terrain of ITV with confidence and resilience. The pursuit of accurate Insurance to Value serves as a cornerstone for protecting policyholders against potential losses and fortifying their financial resilience.

The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials contained in this article are for general informational purposes only.  Policyholders should speak to their agents directly to address any concerns they may have regarding their ITV.