Underinsurance is not exactly a new phenomenon in Latin America. Many countries have long suffered high inflation and the consequent risk of claims settlements being reduced due to underinsurance. So, why was there such a lively debate when 70 insurance executives came together for the Advanta/LEA Breakfast Forum during the 2023 Miami (Re)Insurance Week?
It’s true that high inflation has long been an issue for many Latin American countries, but it’s equally true that many others have benefited from low inflation and relatively stable economies. For widely documented reasons this all changed in 2022 and inflation is a global problem that’s now affecting all Latin American countries. Coupled with rising interest rates and volatile exchange rates it has exacerbated the underinsurance problem across the region. According to Gustavo Rodríguez, Senior Loss Adjuster with Advanta “many commentators suggest that we used to see one in four claims in Latin America affected by underinsurance, but we are now seeing as many as one in two.”
Claims cost rises far exceed headline inflation rates
The Breakfast Forum examined charts showing changes in the consumer prices index and the cost of cement, materials, oil and steel, machinery and transportation among other factors. Clearly, inflationary pressures, currency fluctuations and devaluations are hugely affecting claims costs.
A case study presented during the Breakfast Forum perfectly illustrated the challenge facing insurance buyers. Tomas Fourcade, Director of Advanta in Argentina, took delegates through two identical renewable energy wind turbine claims, one from 2021 and the other almost exactly a year later in 2022. “The cost of reinstatement for the 2022 property claim was 80% more than the one in 2021, and not only that but delays in sourcing replacement parts meant that the business interruption lasted 10 months versus six in 2021”.
There can be no doubt that the value of some goods and materials have increased by a rate that is far greater than the headline rate of inflation. In such a dynamic environment the cost of reinstating property is constantly rising, and supply chain issues and labour shortages are making business interruption limits and indemnity periods inadequate.
A key debate at the Breakfast Forum related to the existence of underinsurance conditions in insurance policies, commonly known as the Average Clause. Most policies will have this clause which puts the onus on the Insured to declare the correct sum to be insured. If this is found to be inadequate when a claim is made then the claim amount is reduced in proportion to the underinsurance.
It was suggested by some that where these clauses were not present then Average should not apply. However, Jose Miguel Varela, Regional Director at Advanta explained that “This is actually written into the insurance framework or law in most countries so Average generally applies even if it is absent in the insurance policy.,.”
The audience at the breakfast forum concurred that underinsurance was a complex topic but there are some simple mitigation actions that could be taken:
It is vital that the insurance buyer is aware of policy requirements and understands the implications of underinsurance. When the value of the claim is reduced by underinsurance it harms the relationship between the parties concerned. Often claims disputes and loss of reputation can be averted through clear communication before the policy is taken out.
- Regular assessment of insured property values
It is important to keep sums insured under regular review and to take account of any structural changes to property, increased stock levels and new plant. It is particularly important to be aware of the point at which the sums insured were calculated and the method used. According to Varela “All too often Insureds set values long before the start of the policy, so they are already too low before we even take account of the period before a claim occurs.”
Firms can appoint a professional valuer such as Leza Escriña y Asociados (LEA) or use tools such as this one they offer (https://www.lea-global.com/calculador), to estimate the reconstruction costs of buildings. Whatever route is taken, it’s important that it is not just a one-off exercise. In this inflationary environment sums insured need to be kept under constant review.”
- Beware exchange rate trap
In many cases, inflation and currency exchange rates evolve in similar directions. This generates an expectation that insured sums in “hard” currencies protect against inflation, but this is not always the case. We are seeing claims is countries, such as México, where there is inflation in local currency but in the same period the local currency is appreciating against the US dollar. Fourcade used a case study of a hotel claim in Mexico which was insured in US dollars to demonstrate how currency fluctuation led to 13.5% underinsurance just six months after a professional valuation.
- Check business interruption indemnity periods
Ongoing supply chain issues and labour shortages are going to continue affecting business interruption. Fourcade suggests that “18 or 24 months indemnity periods should be considered in some activities that previously insured only 12 months”.
- Re-calculate business interruption limits
Changes in the price of commodities and materials are likely to affect a firm’s insurable gross profit. Fourcade suggests “Reassessing these limits using forward looking rather than historical numbers.” Whilst some policies will have protection against inflation this is likely to have some limitations so cannot be totally relied upon.