Accurate valuations are vital for good large property risk management

For the commercial property market and the customers who depend on it to protect their assets and operations, these are indeed “interesting times.” And while that ancient proverb may be apocryphal, the combined effects of high inflation, supply chain problems, more frequent and costly natural disasters, and the lingering impacts of the pandemic continue to impose real challenges on risk managers, insurers and the large property markets in general.

In volatile or stable economic times, one of the most important tasks facing underwriters and risk managers is determining accurate values to be insured. Arriving at accurate value statements will help ensure that all parties to an insurance contract understand the risks covered, the retentions written into the contract, and the potential exposure to the customer’s bottom line. But in inflationary periods like the present, when the costs of everything insurance pays for are rising precipitously and supplies are strained, establishing correct valuations could not be more critical.

Why accurate values matter

Accurate valuations are important for a variety of reasons. For one, values are routinely used for modeling the potential effects of natural catastrophes (CATs). Brokers, risk managers and underwriters will use those modeling results to determine the CAT limits businesses need to protect their portfolios. For another, values will help determine the deductibles that will apply in high-hazard events and are critical in accurately setting policy limits. Finally, values are used to prioritize risk improvements. If loss estimates are not accurate due to inaccurate values, a significant exposure may be left unidentified, potentially giving the risk manager an unplanned retention or an unexpected, underinsured loss.

The increasing values of large property risks driven by today’s historic levels of inflation have placed significant upward pressure on rates. So have more frequent and severe weather events. Understandably, the upward pressure on large property rates has been a major source of frustration for customers. But while rising rates have helped insurers keep pace with inflation to some degree, rate changes alone will not answer the industry’s challenge to stay abreast of fluctuations in large property valuation and loss trends.

Each year, Zurich North America publishes a report compiling Replacement Value Cost Trends. For the reporting year ending January 2023, current trends continue to show an unprecedented increase in construction cost inflation, with an average increase of 12.9% during 2022. Regionally, costs increased in the range of 7.6% to 21.2% based on local conditions. A continuing labor shortage, especially in the skilled labor market, has resulted in higher wages. Material costs were at a high near the beginning of 2022 but began to stabilize toward the end of the year. However, material costs are still up an average of 9.5% for the year. Supply chain issues and costs of building materials in high demand continue to be main drivers of inflation. Additionally, uncertainties associated with the war in Ukraine have had an impact on non-residential construction costs.¹

Valuations drive risk management decisions

For customers and insurers, assuring accurate valuation is more than just an exercise affecting rate adequacy and premiums. Accurate values are fundamental to allocation of capacity, reinsurance decisions, the setting of sub-limits and deductibles, and CAT modeling. Customers purchasing CAT limits across their portfolios need reported values to be accurate from the start so that they, their brokers and their underwriters are making informed choices from the outset. A best practice for risk managers is to use some of the same modeling tools insurers use to help them make informed decisions about the probable maximum losses (PMLs) their organizations might face, and what they should be purchasing in terms of CAT limits. Whatever modeling tools they may use, risk managers need to have established programs in place within their teams to regularly monitor and record changes in property values.

Risk engineering professionals also depend on accurately stated values when performing onsite risk assessments. A full understanding of the total insurable values of a customer’s property, inventory, equipment and potential business income at risk has a major bearing on loss expectancies. The goal of risk engineers is to assist customers in risk management, so they use loss expectancies to develop risk-mitigation plans. If the values at risk are in a range acceptable to the customer and carrier, a loss-mitigation plan will do a much better job helping a customer recover from an event, including a claims payment that accurately reflects the loss. If the valuation is out of date or inadequate, the loss may be seriously underinsured. In some cases, it is possible that inflationary pressures on the reconstruction costs of a partial loss could exceed the stated, insured value of the structure itself. So, the diligent monitoring and reporting of insurable values over time is critically important to avoid the unpleasant surprise of serious underinsurance at the time of a claim.

Keeping valuations current

Underwriters also pay close attention to year-over-year valuation changes to assess how customers are managing their statements of value, and the degree to which their statements of value support the policy terms and conditions provided. If renewal valuations have remained relatively flat for several years, especially in a time of rising inflation, there is a strong likelihood that the reported values are out of alignment and are not representative of the true picture of a customer’s exposures. This is particularly true if the account has added new locations or new equipment and other key assets since their last valuation.

The combined effects of inflation on replacement costs, shortages of skilled labor for repairs and reconstruction, and the persistence of supply chain issues in some industries can dramatically affect the values a customer has at risk. Costs can be further impacted in CAT-prone regions because property that had been grandfathered into old building codes will more likely be required to be brought up to code for that jurisdiction.

Accurate values matter in any economy

Current trends appear to suggest that both inflation and supply chain disruptions may be easing, with hopes for a return to some degree of price stability on the services and materials that insurance policies reimburse for. However, any easing of present-day economic stresses in no way reduces the importance of obtaining and reporting accurate values in the insurance process. Even in a period of low inflation, if a property is not correctly valued the consequences could still mean serious underinsurance, an unpleasant claims experience and a loss of trust in the insurance industry’s ability to adequately deploy precious capacity and protect businesses.

Customers should reach out to their brokers and underwriters to gain clearer understandings about the effects that current trendlines are having on large property insurance and why accurate valuation statements are integral to a successful risk management program.

1. Zurich Replacement Value Cost Trends. Zurich North America. January 2023.