The risk of underinsurance posed by inflation

The “three ‘I’s” that can potentially lead to underinsurance – indexation, inflation and indemnity periods – pose a “reputational risk” for insurance brokers, as well as present a “real opportunity” to “reinforce their value to clients in a huge way”, according to Simon McGinn, chief executive of Allianz Commercial.

Currently, the macroeconomic environment in the UK is riddled with factors that can contribute to the perennial issue of underinsurance.

For example, on 17 August 2022, the Office for National Statistics (ONS) confirmed that the Consumer Prices Index (CPI) rose by 10.1% in the 12 months to July 2022, with rising food prices recorded as the largest contributor to inflation’s upward momentum between June and July 2022.

UK inflation hits double-digits

The ONS additionally revealed that July’s 10.1% figure is the highest annual CPI inflation rate since January 1997.

This “economic volatility” is a “big concern” in terms of driving underinsurance, noted McGinn.

In terms of his “three ‘I’s” analogy, McGinn identified inflation itself, as well as indexation, as possible problem areas that brokers need to keep under close review – the first two “I”s.

Typically used for buildings insurance, among other covers, index linking or indexation uses indices such as the CPI to automatically update sums insured to ensure that an asset’s insured value is adjusted in line with fluctuating inflation, deflation and cost of living rates.

Although index linking is traditionally used to combat underinsurance, McGinn emphasised that there is pressure on the insurance industry to “get indexation right” as consumers’ purse strings are increasingly squeezed by “inflation going strongly”.

He added that there is “pressure on clients to be economic with their reinsurance value or their insurance values because it does drive price”.

As for inflation itself, McGinn told Insurance Times that insurers need “to make sure we’re considering how we manage inflation in the way in which claims are handled”.

He continued: “Do we tell the story well enough about repair not replace, supply chain issues and the sustainability agenda? Are we positioning that well enough?”

Indemnity periods

The final “I” that can contribute to underinsurance is indemnity periods, McGinn said. This is linked to “prevalent” supply chain issues.

The ONS’ Stock and supply chain issues in the UK: Quarter one 2018 to quarter four 2021 report, published in April 2022, found that stock levels in the construction industry have changed by as much as 5% quarter-on-quarter, while the motor trades industry is reporting a stock level that is currently 10% lower than it was in 2019’s fourth quarter.

This analysis recorded Brexit, the Covid-19 pandemic and container ship Ever Given blocking the Suez Canal back in March 2021 as all contributing to struggling supply chains, alongside the shortage of heavy goods vehicle drivers in H2 2020.

McGinn said: “Because those supply chain issues are prevalent, is [a] 24-month [indemnity period] long enough? I mean, 12 months doesn’t seem appropriate at all for business interruption claims these days, [so] you begin to think - should it be 36 [months]?”

This is a trend for “brokers and insurers alike” to consider, McGinn added.

Broker opportunity

The potential combination of incorrect indexation, rising inflation and disproportionate indemnity periods has huge “implications for brokers, their clients and the insurance industry as a whole”, noted McGinn, “because [there is] some real reputational risk around” these three factors and how they can possibly cause customers to become underinsured.

However, McGinn believes there is also “some real opportunity” for brokers to step up to the plate and help mitigate underinsurance.

He explained: “When times are tough and the world is uncertain, the ability for brokers to provide expert advice with confidence and clarity will reinforce their value to their clients in a huge way.

“Our job is to manage the risk - to either transfer it away or maintain the balance sheet, just to make sure people aren’t exposed.”