Q. If you had to single out one thing that you’d recommend risk managers to do to mitigate against inflationary effects, what is it?
Hugo: Revisit valuations and policy limits. This is a theme you’ll see coming up again and again in the linked articles on this page. Put simply, if your building burns down, it is going to cost more to rebuild it because materials will cost more. Plus, we know that labour and materials shortages globally have been exacerbating cost pressures for a while now and have typically extended the length of time it takes to get up and running again – which adds uncertainty about reinstatement and business interruption costs. As we’re not sure how long this period of higher inflation might persist, it is better to be safe than sorry.
One other thing I’d caution companies about is a growing need to factor in ‘green replacement’ as part of the increased focus on ESG (environmental, social and governance) in the financial and risk community. That’s not inflation driven per se but is another element that inflation will impact.
Q. What about inflation and liability covers?
Hugo: The same thing; valuation, but for different reasons. The main driver of the need for higher liability limits is social inflation, primarily the value of legal settlements and the prevailing impression that there’s no such thing as bad luck these days. Someone has to be at fault for any event it seems.
Everyone’s first thought goes to the U.S. when talking about this, but, from where I sit, the rest of the world is catching up. And economic inflation is a factor in that it’s likely to encourage plaintiffs to go after larger settlements. The other thing to think about here is the industry you’re in, so that you’re taking account of industry-specific risks and trends.
Q. So, valuations need to be adjusted for inflation. Is it a case of adding a few percentage points on current valuations?
Hugo: You could do that, but it’s certainly not what we at WTW would recommend.
In this inflationary environment, I fully expect insurers to be extremely harsh towards clients whose valuations they don’t trust or deem incorrect and, in such cases, either offer them indemnity or average payouts, or maybe even more restrictions where they suspect deliberate under-insurance.
The smarter way forward, in our opinion, is to really invest in presenting risks to insurers with the right information and with as much empirical evidence and data to back up valuations as you can reasonably muster.
Q. Hugo, you were recently quoted in an industry publication saying that you think businesses shouldn’t just accept inflation-based rate increases from insurers. Would you like to expand on that?
Hugo: Yes, I did say that, but the intention of my comment was a bit more nuanced than it perhaps came across in the article. What I was actually referencing is the need – and the potential opportunity for insurers – to differentiate between rates and premium.
I wouldn’t presume to tell insurers what rate they should be charging for a certain level of risk, but the reality of a higher inflation economy is that if clients increase valuation and limits to reflect it – as they should - insurers will be getting more premium to cater for this. Now, I realise of course that insurers’ own costs of doing business are likely to rise, but I think this is a relatively small part of the premium. I would rather see insurers taking the the route of insurance product innovation to increase premium income that covers their costs, for example.
Q. That’s three top tips then – valuations, evidence and dialogue with your risk advisors and insurers?
Hugo: If you want to put it that way, yes. And all are things that risk managers can do without waiting to see how this period of higher inflation pans out or how long it lasts.
