
Background
Have you recently placed a piece of business and the carrier questioned “when was the last time the Schedule of Values was appraised on a replacement cost basis” or focused in on the cost per square foot being too low?
It seems strange that after so many years carriers are only starting to ask about valuations. Why did they not ask before now?
Many schedules didn’t even have an index linked inflationary increase.
So why start now?
The simple reason is that Underwriters and Reinsurers have been paying out more for losses than they should have been due to values being understated, having received premium on the stated values and then paid out on higher values due to increasing replacement costs.
This has led to reinsurance being called upon and capital being used to supplement the difference to balance the books.
In some areas, insurers have completely pulled out of a territory due to local legal conditions creating a situation where they are unwilling to operate anymore.
What is driving this situation?
The pandemic’s strain on labor supply and the supply chain has given rise to a construction backlog in housing and exacerbated soaring costs thus rendering many valuations which have not been updated over the past couple of years obsolete.
Inflation – this has really highlighted the situation due to the increased demand after Covid, supply chain issues driving up the cost of building supplies, as well as the additional knock-on effect caused by the War in Ukraine driving energy prices up.
Validation of values – historically, values have not been reviewed by insurers or challenged to ensure they are correct at inception. How many clients typically re-appraise their values every year to ensure they are up to date?
Legal environment inflation, where courts side with the Insured’s rather than the Policy language forcing inflated claims payments by ignoring policy conditions.
Mid term
With current high inflation it is probably worth checking values every 3 to 6 months so the Insured does not fall foul of any restrictive policy conditions.
It is probably worth negotiating a percentage values inflation margin, so the Insured doesn’t get penalised in the event of a loss.
Common Underwriters Controls
Underwriters may apply certain conditions to control claims pay-outs if the replacement costs at the time of loss are significantly higher than those originally declared. Ultimately this might result in claims not being fully paid due to policy restrictions.
Examples are: -
Coinsurance Clause: This clause normally provides a small (10%) percentage allowance before any restriction in pay-out is made via the average clause.
Average Clause: This clause calculates the loss at pro-rata. If the values at time of loss are 100% of what they should be then Underwriters will pay in full, however, if they are incorrect the client will only receive a proportion of the declared values versus correct values whether inflated or over inflated. This can be penal if the values are declared incorrectly.
Margin Clause 110%: This clause is currently common in the London market and protects both client and underwriter. It states that Underwriters will pay up to 110% of the values listed on the schedule. Therefore, if they are all stated correctly at inception and values go up due to inflation underwriters are recognising up to a 10% difference without penalty.
The percentage allowance can be negotiated with additional premium and a narrative to provide reasoning.
Basis of Valuation
Replacement cost – the cost to replace with similar quality materials and workmanship.
Actual Cash value – Replacement cost value less depreciation.
Stated amount or agreed value – Agreed value is an agreement between the Insured and the Underwriters on the value of the asset being insured.
Some Insureds depending on their schedule and capital funding may decide to take a mixture of valuation types. This is fine as long as the basis of valuation is clearly defined on the schedule of values, and subsequently accepted by Underwriters.
Valuation services and Loss adjustment
The industry seems to use the Marshall and Swift method for the basis of adjustment, so it would make sense that any appraiser also uses the same method.
The Loss Adjuster at an early stage of a claim will look at the loss from a valuation standpoint and want to ensure everything has been declared correctly from inception and adjust the loss on the same basis.
Why is important to get it right?
If everything is declared correctly at inception, and premium paid based on these values, any claim should be paid without argument as the last thing the Insured and/or underwriters really want is to dispute a claim over insufficiently declared values.
The main purpose of insurance is to put the client back in the same position he was in prior to any loss.
Whilst we are currently seeing significant renewal price increases due to market conditions, increased values are also driving premiums up, however it is important to get values correct to ensure the Insured programme responds as intended at time of loss and not subject to policy declaration penalties.
Summary
The market has hardened so much due to the inflation on claims over the past 2-3 years and it is in everyone’s best interest to ensure valuations are correct from inception, so both Insured and Underwriter are on a level playing field.
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