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Property undervaluation risks escalate amid high inflation

High inflation, supply chain challenges, and a shortage of skilled labor are causing significant increases in the cost of construction. As a result, property values have also increased significantly. Learn 5 actions you can take now to improve valuations ahead of your next renewal.

High inflation and the increasing claims experience have resulted a greater focus by insurers on the accuracy of insurable values for both property and business interruption (BI). With the rising costs of property repair and replacement, supply chain challenges, and a shortage of skilled labor, accurate valuations are essential. The insured replacement costs of many commercial properties across the US have also increased substantially — an analysis by Associated General Contractors found that materials and services used in nonresidential construction went up by nearly 21% between April 2021 and April 2022 alone.

For property owners, the current landscape poses a new challenge: What will it cost you to rebuild following a catastrophic loss? And is your existing property coverage still adequate? In the face of an anticipated above-average hurricane season and the ongoing threat of wildfires, earthquakes, convective storms, and other natural catastrophes, it is important to revisit insured values, policy limits and sub-limits, and other elements in the insurance contract to assess how your policy might respond to significant increases in costs to rebuild and restart operations.

Laser focus on data adequacy

Property insurance pricing has increased for several years and is still trending upwards. And, as the costs to rebuild and recover fluctuate, insurers are focusing more acutely on valuation of properties and reported business interruption figures.

Accurate values are also important to the client decision-making process. Property and BI values and allocations underpin the calculation of location loss estimates. Inaccurate location values and loss estimates could lead to incorrect insurance limit setting.

With heightened underwriter scrutiny, insureds are under pressure to more reliably report replacement values that reflect the current construction environment. If insurers are not satisfied that reported values are accurate, they may introduce coverage limiting clauses, endorsements, and provisions during your renewal to help mitigate risks related to undervaluation.

Some insurers may try to impose a coinsurance provision — effectively a charge to be borne by the insured when there is a loss, resulting in a lower insurance payout. Insurers may also limit coverage for one or more locations to the values reported. In some instances, insurers may agree to a margin clause, which typically states the maximum amount paid is between 110% and 125% of the reported value. Insurers may also opt not to renew policies where they view the reported values as being well below market averages or where an insured has sustained prior losses that exceeded the values previously reported.

Aside from complicating the loss recovery process, policy wording that limits coverage to the values reported can potentially put insureds at risk of violating lender requirements, lease obligations, or other agreements to maintain a specified level of insurance.

6 actions to improve property valuation

Insurers rely on the accurate reporting of replacement values to determine premiums, decide how to deploy their capacity, and in some instances, purchase facultative reinsurance. Insurers expect insureds to report accurate replacement values in line with valuation conditions established at the start of the policy term. As construction prices remain high, and supply chain challenges lead to longer timelines and delays, it is wise to consider the following actions ahead of your next renewal:

  1. Start the process early. Insurers typically require updated values for insured locations to be submitted between 60 and 90 days prior to the renewal date. Considering the increases in construction costs, allot enough time to carry out an in-depth valuation of insured properties that can be shared with underwriters. This work can actually be carried out early during the expiring policy period and adjusted before renewal. In situations where the schedule of values consists of many locations, insurers may be willing to work with insureds and agree to a plan to review the valuations over the next few renewal cycles if it is not possible to do the entire portfolio before the upcoming renewal.
  2. Identify the most suitable index. Insurers typically react unfavorably to insureds moving among different indexes year-to-year. Aim to select the index that best fits your business — and stick to it. Note that variability between sources can often be attributed — at least partially — to trend data release dates and data lag-time within each source.
  3. Carry out a benchmarking exercise. Benchmark estimates use limited data points to provide a rough preliminary guidance around values, serving as an important first step in your property valuation exercise. While benchmarking exercises are only the starting point for activity and discussions, they can provide an estimate of property values until a detailed valuation can be carried out.
  4. Plan the valuation process. Reviews of property values and valuation of the buildings and contents for large projects can take several months.. Identify the internal and external team of specialists that will work on the valuation process; your broker or insurance advisor may be able to assist. Collect needed data, including statements of value, property condition assessments, site surveys, scaled drawings, or prior property valuations.
  5. Carefully review your business interruption values. Values should be allocated based on where value is generated rather than how values may be allocated for tax or other purposes. To support your loss estimate calculations you can assess the impact of BI mitigation through an anticipated maximum business interruption loss study (AMBIL). Such a study will help establish a confidence level around your ability to recover full output at any location. For manufacturing operations with interdependency across locations or product lines, organizations can conduct a value stream mapping exercise to best understand the aggregate BI exposure from different loss scenarios.
  6. Consider your downtime. Supply chain challenges together with a shortage of skilled labor may lead to longer rebuild timelines. Also, it may take significantly longer to replace or repair damaged equipment. Work with your appraisers to determine how these longer timelines will affect the organization’s output when calculating business interruption figures.

As these challenges continue to impact the value of properties and their contents, organizations should assess the adequacy of their insurance coverage on an ongoing basis and aim to make adjustments that will help them to recover following a catastrophic event.

For further information, contact your Marsh broker.