- Inflation is a major challenge for many businesses. It also has a significant impact on business insurance coverage, but the underlying causes and effects may not be well understood by your commercial clients.
- Inflation affects insurance rates largely because the dollar value of the risks being insured increase. Property values and replacement/repair costs is a key example of this phenomenon.
- Business insurance customers may be at higher risk of exposures if they do not take certain steps to ensure adequate protection.
- Reviewing coverage to ensure appropriate limits and insuring-to-value is critical during an inflationary economy.
- Loss control measures are important steps to mitigate risks that may be exacerbated by inflation.
Despite widespread economic concerns, only 27% of business owners have talked with their agent to review their insurance policy this year.
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How does inflation impact business insurance?
The annual inflation rate increased from 3.2% in 2011 to 8.3% in 2022. Inflation surged as high as 9.1% in June 2022.1
Inflation can have a significant impact on insurance rates, as well as other effects related to insurance coverage. While the specifics can be complicated and multi-variate, the simple way to understand how inflation may drive an increase in rates, is that the dollar value of the risks being insured goes up. Insurance losses increase even if the frequency of claims remains stable, because the costs of claims are inflated.
This substantial rising cost of claims can be seen across various categories of insurance losses, including medical services and vehicle repair/replacement. Perhaps most significantly for commercial insurance policies is the impact on commercial property.
Inflation and commercial real estate
The cost of building materials increased by 8.3% in 20222, which leads to higher replacement costs for insured property. For example, if it cost $1 million dollars to replace a business's real property last year, it might cost $1.2 million this year.
Labor cost inflations
In addition to inflation in building materials, the rise in labor costs also increases the total repair cost for building damage. According to Reuters, labor costs increased 5.1% in 20223. Customers may find themselves underinsured, as it relates to estimated replacement cost for real property.
For business insurance policies that include loss of income, it is also critical to evaluate business income coverage limits. Inflation may impact sales, wages, and the amount of time to repair property, all of which could impact business income. Supply chain delays can also delay a business from returning to normal operations, which increases the severity of lost income. Supply chain delays and disruptions are predicted to continue in 2023 because of the pandemic and inflation4.
Commercial insurance policyholder premiums
As increased repair and rebuilding costs raise claim severity, premium rates will ultimately reflect this inflated claim costs. Commercial property insurance rates have steadily increased since Q3 of 2017 and are expected to continue in 2023. Experts predict premiums will increase between 10% to 25% this year.5
Commercial Property Cost Factors Infographic
What actions should business customers take to mitigate risks due to inflation?
- Review business insurance policy details and coverage limits. Under the current economic conditions, one of the biggest questions for a commercial property owner to consider — from an insurance perspective — is if they have adequate coverage.
- Review policy terms and conditions to ensure you are fully protected if a loss occurs.
- Evaluate issues that could impact coverage, such as how labor and supply shortages may affect estimated replacement costs.
- Confirm that replacement cost coverage is part of the policy and that the replacement cost estimate is accurate.
- Reassess property valuations. During inflationary periods, it's especially important to review property valuations annually to ensure coverage is keeping pace with costs.
- Detailed information on the covered property's construction can impact the valuation. This review should include real property (buildings, pavement, land, plumbing, electrical, etc.), business personal property (such as furniture, machinery, supplies, tools, etc.) and business-income limits (loss of income or profits due to covered peril).
- Insuring to value so that coverage keeps pace with the increase in the cost of repairs is critical. Business owners should consider how inadequate coverage or appropriate limits could impact their operations in the future.
- Implement risk management and loss control programs. Even during lower inflationary periods, a business's bottom line can be impacted by the specific risks it faces. Creating a strong safety culture can reduce frequency and severity of losses and reduce the potential of out-of-pocket claims costs.
- In addition, businesses that have established risk-mitigation practices — such as training their employees, reinforcing the importance of loss prevention, and developing a business continuity plan — perform much better than businesses that do not have these characteristics.