Putting a lid on the property valuation problem once and for all
Who is responsible for ensuring that property reinstatement values are accurate? Is it the Policyholder? Should the Broker step up? Is the Underwriter in the best position? If no one takes the lead then the spectre of underinsurance will arise, with potentially devastating effects. And yet there has been no time in living memory where accurate values have been more important than now.
If you are an Insurer or Broker involved in the commercial property sector you will need no introduction to underinsurance. Fuelled by inadequate, inaccurate and unsubstantiated property reinstatement values, underinsurance is now a truly out-of-control conflagration as a result of the spectacular rates of inflation, currency exchange rate fluctuations and severe supply chain constraints we are experiencing post-pandemic.
The chart below illustrates the dramatic increase in the price of industrial equipment since the middle of 2020, in the case for the European Union, and one needs to go back to the early 1980s to see a situation anyway close to this in terms of global impact.
Previously, underinsurance was an irritation for Insurers and a headache for Brokers, but now it is an unbearable affliction. In a world of double-digit inflation, acute construction labour shortages and almost inconceivably long equipment lead-times it is no longer possible to simply ignore this underlying issue. But how can we solve a problem this longstanding and this severe?
Let’s look at the issue through the lens of the very real case which we recently uncovered through our work here at Virtual i Technologies.
A food manufacturing company in East Africa has a single beverage factory and a number of small warehouses for distribution of its various juice products. As is common for most medium-sized businesses, it had never been subject to a Risk Engineering Survey, and so the Insurer relied entirely upon the Broker’s submission for generating the quote.
When it was uncovered that there was a small claim which had not been notified at the time of renewal, the Underwriter thought it prudent to take a closer look at the risk quality. This is where we at Virtual i Technologies entered the fray, performing a remote Risk Engineering Survey of the beverage factory using our unique platform [VRS]TM Virtual Risk Space.
From one perspective the survey succeeded in calming the Underwriter’s nerves; the exposures were revealed to be low, and the protective measures in place were adequate. However, three revelations were made in relation to the property reinstatement values, each more startling than the one before;
- The declared value for the first production line was simply the actual project cost from 2009, which had not been inflated or restated in the 13 years since then. The equipment was supplied by a large EU-headquartered manufacturer, and with industrial prices in Europe now 43.6% higher on average than in 2009, there is no hope that production line components could be sourced for anything close to the value that it was now being insured.
- A smaller second production line had been added in 2018, but this consisted of pre-used refurbished equipment which was purchased for around 55% of the cost of a brand new line. This was a relatively fortuitous situation, as the Insured was in the market for an additional production line with this specification, and this complete system just happened to become available at that time. Such a situation could not possibly be relied upon to repeat itself following a catastrophic loss incident.
- The factory building – a reinforced concrete building with two floors and a total floor area of 5,400 m2 – was declared as having a replacement value of only USD 18,270. Upon investigation, it was discovered that the building was rented for the first five years of operation and then purchased outright in 2014 for what appeared to be a token amount of money, as the building was in need of upgradation. The Insured then spent – you guessed it – USD 18,270 refurbishing the building….
Taken together, these represent an all too common underlying issue; a fundamental misunderstanding of the basis of indemnity, leading to huge underinsurance exposure for the Policyholder, a potential liability lawsuit for the Broker and the double whammy of lost premium and potential litigation for the Insurer should they attempt to impose the average clause.
In other words, a huge mess just waiting to land on everyone should a claim occur.
In almost every survey we at Virtual i Technologies conduct there are similar problems. At a newly commissioned Anaerobic Digestion Biogas plant a tank was structurally damaged when a commissioning step went wrong. The replacement cost for the tank was 218% of the original cost, even though the original purchase had only been made 18 months before! Despite this fact, no stakeholder – neither the Underwriter, the Broker nor the Policyholder – realised that this undermined the entire reinstatement cost for the facility when it came to creating the first operational policy for the plant. In a power station which we recently surveyed, the declared value of a 168 MW gas turbine generator was only 55% of the value of the exact same machine at another facility in a nearby country. We were able to highlight this not because we are a valuations company, but because errors of this magnitude are easy for a professional Risk Engineer to spot.
But to spot it, we need to see. And with [VRS]TM Virtual Risk Space you now can. Policyholders can be forgiven for being ignorant about replacement cost values, it’s simply not their field of expertise. In a high inflationary environment it is vital that Insurers and Brokers work in tandem to help the Policyholder reach the right understanding in relation to their declaration.
As for volatility in business interruption values, that horror show can wait til after Hallowe’en…!
