Recent years of stable inflation and low interest rates in the U.K. have lulled many companies into infrequent reviews of potential business interruption (BI) costs and the resilience of the cogs in their supply chains to financial stresses. The change in economic mood ought to be the signal to change that.
As U.K. inflation and interest rates have entered territory not seen for some time, the fundamental effect has been to raise questions about the future value of money, in particular what this means for business costs and margins.
Businesses that can better quantify these uncertainties, more effectively mitigate the risks, and insure at levels reflecting rising costs will be better-placed to weather inflationary pressures. Against this backdrop, this article considers inflation and the specific impact on business interruption and supply chains.
At its core, BI insurance cover relies on predictions of future losses of revenue and margin due to damage to or the destruction of business premises. So, what can we conclude or reasonably speculate about how higher inflation is likely to impact and influence the BI insurance market?
One obvious effect is that insurers’ own costs of doing business will rise and may lead to more expensive premiums for insureds. Linked to that, market capacity is based on financial limits so, unless insurers raise finance to increase that capacity, the shrinking value of that capacity will increase competition for the available risk capital and put further pressure on prices.
But the inherent cost of BI insurance is just one side of the inflation coin. The other is the effect of inflation on valuations of the costs of restoring to working order what is being insured.
Think, for example, how long it typically takes to rebuild a severely damaged property. If higher inflation proves hard to budge, or perhaps even increases a bit more, the reinstatement costs will be continuing to rise and compounding month-on-month or year-on-year. Factors such as shortage of labour and shortages of materials are complicating cost drivers that must be taken into account. Moreover, the cost of replenishing any equipment, stock and supplies that were housed in the damaged property will rise with inflation and either have to be insured to the right level or passed on to customers (which may be difficult).
Higher supply chain costs are an almost inescapable result of rising inflation as all companies seek to raise prices to offset increasing costs. Beyond that, businesses will also need to be mindful of the resilience of their supply partners going out of business as energy and labour costs in particular mount. Even where that’s not the case, it’s quite possible that the supply of some goods and services in certain industries will become constrained.
Transport and logistics are also likely to be impacted. Storage and container availability and costs, which had only just started to stabilise after rocketing during the height of the COVID pandemic, will again come under pressure. Distribution tariffs are also likely to be prone to inflationary rises. And another factor in increasing supply chain costs – not to mention governance – is the growing scrutiny of environmental, social and governance (ESG) principles by investors, regulators and customers.
What this all adds up to is, in the last 10 or so years most organisations have worked on a basis of a 1% to 2% annual increase in supply chain costs, that figure is now going to be much higher.
Elevated costs, and potentially higher continuity risks, will need to be reflected in both insurance cover and the approach to planning. Indeed, it’s interesting to note early signs of moves from some companies from a just-in-time supply mentality to just-in-case and, with that, a revival in near-shoring and onshoring in preference to offshoring despite the likely cost implications.
A valuable part of planning, especially given the difficulty of predicting exactly what will happen with inflation - particularly across multinational supply chains – can be scenario planning. Essentially, it should enable the organisation to map out options with regards to pricing and supply chain management in the event of a range of inflation and cost increases.
That, as you may imagine, is not an elementary exercise. So, perhaps a third pillar in building supply chain resistance to inflation will be the need to look around at the tools that enable you to forecast more confidently.
In looking at economic developments and the rise in inflation during 2022, what we can say with a high degree of confidence is that we are living in a very different world from that of recent experience – and for some in business, their only experience.
In the absence of an inflation oracle, many companies’ best form of BI cover and supply chain defence will be to attack and update their understanding of the cost implications for their own businesses.
For further information on inflation risk, please get in touch.
