Inflation, rising catastrophe costs challenge Property lines

by Alex Wells, Head of U.S. Middle Market, Zurich North America

This article is the fourth in a series focusing on the current and historical trends for various commercial insurance products.

Trends in Commercial Insurance, Issue 4 of 4: Property Insurance

In looking at near- and medium-term factors that will continue to affect the commercial property insurance markets in the year ahead, it is a certainty that insurers, brokers and customers will continue to experience the effects of inflation combined with more costly natural catastrophes. While there is not universal agreement about whether the tempo of natural catastrophes represents greater frequency, there is no doubt that the impacts of these events are being amplified as more values are exposed with expanding commercial and industrial development in geographies where severe weather occurrences have not had as great an impact in the past.

The increase in properties at risk of natural catastrophes is further complicated by an environment of rising inflation, which impacts the replacement cost coverages incorporated into commercial property insurance contracts. Put simply, if the values being insured are not up to date and have become significantly understated due to inflation, the result can be unpleasant surprises at claim time as well as impacts on insurers’ abilities to allocate capacity at renewal.

The value of accurate valuations

A recent article in Business Insurance observed that “the spike in inflation has rippled through the insurance industry from higher construction and auto fleet costs to valuation reviews that are surprising some.” The piece noted that uncertainty caused by an uneven emergence of businesses from the pandemic has made coping with change more challenging.¹

Each February, Zurich North America publishes a report compiling Replacement Value Cost Trends. Our recently released 2022 report notes that current building cost trends show an unprecedented increase in construction cost inflation for the year ending January 2022, with an average increase of over 12% for the year. Regionally, costs increased in the range of 10% to 15% based on local conditions.²

For underwriters, inaccurate valuation is more than just an issue affecting premiums. Accurate values are fundamental to overall risk assessment, allocation of capacity, reinsurance decisions, the setting of sub-limits and deductibles, and natural catastrophe modeling. Underwriters typically 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 support the policy terms and conditions being provided.

Properly monitoring and stating of values is in the best interests of customers as well. Risk managers need to ensure they have adequate insurance in place for the values they have exposed, and that there will be no surprises at the time of claim. If renewal valuations have remained relatively flat for several years on an account that has not experienced the addition or disposal of insured locations, the valuation is likely out of alignment and needs to be addressed.

This is the reason why we recommend that property customers have a program in place to ensure they are continuously managing statements of value, not only to reflect the addition or removal of locations but also to account for the impacts of inflation and other factors.

At issue are the rising costs of everything that goes into the partial or complete replacement of a facility in the event of loss — from construction materials and labor to the costs of new equipment and restoration of stock and materials. At a time when inflation was hovering around 1%, its impact on values and replacement cost may have been within acceptable limits. However, in an environment of high inflation the impact on replacement cost is significant, and the potential for underinsurance is real.

The issue of valuation is further complicated in catastrophe-prone geographies by the fact that thousands of insured businesses will be seeking construction and professional services, such as roofers and other trades, to begin repairs on their properties all at the same time. As a result, the costs of labor and materials will increase substantially, anywhere from 10-15%, which will directly impact loss costs. In addition, increased costs associated with updated building ordinance requirements may come into play when facilities are rebuilt to current standards.

Obviously, customers understand the need to update for new and disposed locations, but are they also cognizant of what goes into replacement cost? Do they have a process to trend costs annually? Do they work with a third party to help them assess their replacement costs through appraisals or estimation services? Are their sources of information reliable and adequately keeping pace with cost trends? Are they cognizant of inflationary and supply chain pressures that may affect one region or territory, or their particular occupancy more than others?

Stormy weather

As noted earlier, the effects of out-of-date valuation statements can be compounded by the potential for increasingly destructive and costly natural catastrophes.

According to data compiled by the National Oceanic and Atmospheric Administration (NOAA), in 2021 the U.S. experienced 20 separate billion-dollar weather and climate disasters, placing last year in second place for the most disasters in a calendar year, behind the record 22 separate billion-dollar events in 2020.³ And the diversity of 2021 natural disasters also made it a standout year. In addition to tropical cyclones Elsa, Fred, Ida and Nicholas, a flock of severe weather events swept across the nation, including:

• A winter storm/cold wave event across the deep south and Texas
• Wildfires across Arizona, California, Colorado, Idaho, Montana, Oregon and Washington
• An ongoing drought and heat wave across the western U.S.
• Major flooding in California and Louisiana
• Three particularly devastating tornado outbreaks, and a powerful derecho windstorm that tore through the Midwest in December

These sorts of occurrences are often called “secondary perils” by underwriters, distinguishing them from what many view as the primary catastrophic natural hazards of hurricanes and earthquakes. Those primary hazards are the ones most anticipated to cause massive property damage and financial loss but calling the broader range of natural hazards secondary perils in no way diminishes their growing threat. Hail, tornadoes, flood, wildfires, stronger convective storms, extremes of heat and cold and other secondary perils are becoming increasingly dangerous and costly, complicated by shifting weather patterns that are changing the character of natural hazard risk in some regions. For instance, tornadoes are beginning to occur in parts of the country well outside of the traditional “tornado alley.” And “100-year” and “500-year” floods due to heavier rainfalls attributed to climate change are happening more often than their categorizations would lead us to believe.⁴

Recent climatological history suggests that customers need to focus much more closely on exposures they may have to all evolving natural hazards, not just the potential impacts of such critical catastrophes as hurricanes and earthquakes. Customers need to understand the options available to make their businesses more resilient. This could mean modifying structures with defenses such as flood barriers and water diversion techniques to mitigate against flood losses. In the event of wildfire, procedures should be in place to shut down HVAC systems to help prevent against smoke damage and contamination, among other protective measures.

The value of collaboration

Like most business trends, the current pressures on property insurance rates and capacity, driven by the tag team of rising inflation and more costly natural catastrophes, will ultimately attain stability and equilibrium. Greater focus on customer/insurer collaboration to enhance business resilience and sustainability by mitigating evolving climate risks will pay dividends down the road. Inflationary pressures will ease as they always do in our dynamic, resilient economy. Right now, the most critical need for customers will be to make sure that property valuations are up to date and to better understand what their statements of value are supposed to represent.

Customers should reach out to their brokers and underwriters to gain clearer understandings about the impacts that current trendlines are having on property insurance and why accurate valuation statements are integral to a successful program. We are indeed all in this together, and together we can weather the challenges of an evolving property market to ensure that all businesses have the risk management programs, support and capacity they need for the road ahead.

1. Lerner, Matthew. “Inflation puts pressure on insurers, policyholders.” Business Insurance. 14 December 2021.
2. Zurich Replacement Value Cost Trends. Zurich North America. 18 February 2022.
3. Smith, Adam B. “2021 U.S. billion-dollar weather and climate disasters in historical context.” National Oceanic and Atmospheric Administration (NOAA). 24 January 2022.
4. Mishall, Joffre. “To drive sustainability in a changing climate, focus on preparedness.” Zurich North America. 10 November 2022.