We may start to see movement from the market to amend property and business interruption (BI) wordings, insurance and risk manager should continue to stay vigilant. There are several areas of property and BI wordings that might need greater scrutiny, we explore these in this article:
Where companies have not factored inflationary pressures into valuations for property and BI insurance, there may well be consequences for underinsurance built into policies, such as average (or coinsurance) clauses.
If the sum insured is below the value at risk, it is likely either the basis of settlement will revert to ‘indemnity’ or a pro-rata condition of ‘average’ may apply. This is where the value of any claim would be reduced in proportion to the underinsurance.
The declared values are vitally important as insurers are increasingly limiting their liability by:
Equally, some carriers have traditionally offered some inflation leeway by way of a margin clause (allowing an additional percentage fluctuation) or have taken into account inflation by index-linking, therefore allowing a limited increase in the values each year.
But any significant increase in property reinstatement costs, such as increases in material and labour costs, shortages of commodities such as concrete, steel, timber due to supply chain issues, and labour shortages, creates the potential for underinsurance.
Many insurer wordings, under a basis of settlement clause, state that in the event of damage or destruction of property, the work of reinstatement must be commenced and carried out with reasonable despatch. If such reinstatement is not carried out, insurers may well revert to ‘actual cash value’.
Since some insurer wordings limit the time period in which the work of reinstatement must be carried out before applying actual cash value, increased scrutiny of insurer wordings will be beneficial.
Where material / property damage cover is arranged on a ‘day one’ basis, the insured declares the reinstatement values (the declared values) of the property to be insured at the site/location that would apply if reinstatement could be completed on day one. The insurer’s maximum liability is then expressed as a percentage of the declared value, typically 115% - 125%. The percentage uplift is an allowance for inflation during the period of reinstatement. This basis of settlement tends to apply to buildings, machinery, and contents items; it does not usually apply to stock.
Average applies on the day one declared value and so avoids the insured being penalised should they underestimate inflationary effects on replacement / rebuilding occurring after day one. For this reason, day one is the preferred basis of loss settlement.
However, be aware some insurers do not provide day one cover so no provision is made for inflationary factors on the values.
Where these costs are included within the sums insured/declared values, companies will need to make sufficient allowance for inflationary effects to avoid potential underinsurance. And where these items hold their own inner limit, sub-limits should be reviewed and increases obtained from insurers where possible to allow for inflationary increases.
In the case of debris removal, it is worth noting some insurers are imposing very restrictive time limitations to notify the intention to claim and the amount of claim. Therefore, careful vigilance of wording is needed.
Some protection for inflation is built into many UK BI policies through a declaration-linked mechanism. This typically caters for one third growth3 in estimated gross profit or revenue over the indemnity period. However, across sectors, companies are likely to need to factor increased utility/energy costs into their calculations.
Another area for scrutiny is the BI indemnity periods themselves. For example, uninsured costs and loss of revenue or profit could result from failing to reinstate a damaged property before the indemnity period expiry date. The previously mentioned supplies shortages and supply chain issues also have to be borne in mind.
Companies may also find themselves affected by the reduced levels of trading that took place over the pandemic and the widespread uplifts in pricing and wage inflation that have occurred post-lockdowns. Depending on the indemnity period, this could lead to significantly lower payouts on a claim than companies might have anticipated.
Increased claims frequency, both on liability and motor policies, is a symptom of inflationary/cost of living increases, particularly in times of financial hardship. Making insurance claims for relatively minor (and in some cases fictitious) injuries seems to increase during such periods1.
Damages inflation is sometimes overlooked when setting limits of liability. For example, we recently saw an employers’ liability case which involved employees working in groups, yet the primary plus excess layers amounted to only £25M. To put this into context, the case of Norton v Collier – 2012 (a motor case) saw a damages pay-out of circa £24M for a single claimant who suffered life-changing spinal injuries. When workers are working in groups in a ‘dangerous’ occupation, adequacy of limits needs to be assessed on the assumption that a single severe incident could affect more than one employee simultaneously. For minor injuries such as slips, trips and whiplash, the small claims limit has now been raised from £1,000 to £5,000. Whilst this may deter some frivolous claims, the tendency for a claim to exceed the £5,000 threshold to ensure the claim is cost-bearing can’t be ignored.
Also, with National Health Service (NHS) waiting lists as they are, more injured claimants are likely to be advised by their lawyers to seek private (and costly) treatment in order to mitigate delays in recovery2. The courts appear to be sympathetic to such claims for private treatment and are not disallowing claims due to claimants not being prepared to wait for NHS treatment.
When it comes to compulsory insurances such as employer’s liability and motor insurance, insurers cannot really change wordings as cover has to be provided as required by the legislation. With public liability coverage, it is more likely premiums will increase to reflect increased claims costs, rather than wordings being restricted further.
In summary, the inflationary pressures on insurers’ claims reserves may manifest in increasing premiums, differential terms or tightening of wordings by way of reduction in inner limits, increased time excesses or waiting periods, reduction in indemnity periods for certain BI coverages, or additional restrictions being imposed.
As such, companies, and their brokers, should be alert to the potential impact on the cost and scope of their insurance coverage.
1 Making insurance claims for relatively minor (and in some cases fictitious) injuries seems to increase during such periods.
2 seek private (and costly) treatment in order to mitigate delays in recovery
3 one third growth
