Anytime an area is hit with a catastrophic event, like a hurricane or wildfire, the cost of labor and building materials temporarily rises due to increased demand as communities and businesses rebuild. 2020 brought a total of 63 catastrophic events including Midwestern tornadoes, Western wildfires, and Southeastern hurricanes on top of the COVID-19 pandemic - a catastrophic event unlike any in recent history.
Unprecedented in scope and length, it significantly decreased economic productivity and disrupted global supply chains, even as the demand for building materials and labor increased in the aftermath of devastating disasters. Now, 18 months since the pandemic’s start, continuing supply chain pressure, a shortage of housing market inventory, and nationwide post-pandemic demand surge means the cost of building materials and labor are quickly outpacing inflation rates, creating new risks for businesses that may need to rebuild after a property loss.1
WHAT DOES THE RISE IN BUILDING COSTS MEAN FOR POLICYHOLDERS?
The demand for building materials and labor created by 2020’s disaster events, combined with reduced capacity due to the pandemic, have resulted in significant cost estimation increases and Insurance to Value (ITV) changes.2 On average, reconstruction costs have increased 8.1% nationwide since January 2020. Material costs have jumped an average of 5.2%, with lumber prices alone skyrocketing 85% in some areas. In addition, labor costs have grown by 3.8% - 8%, due at least in part to a worker shortage, especially in areas hit hard by winter and spring storms where demand for construction materials and qualified workers was higher. The scarcity of materials has also been amplified by supply chain pressure resulting from extenuating circumstances like the recent Suez Canal blockage. These pressures and others are expected to impact the supply of materials and equipment for months to come.1
Understanding how the pandemic impacts and recent catastrophic loss events are impacting industry-wide ITV calculations is important because accurate valuation is vital to ensure policyholders have appropriate coverage in the event of a loss.2 Remember, it’s not just about the physical value of the building. With labor shortages and more expensive materials, many businesses are experiencing delays in post-loss recovery, putting their businesses at risk of exceeding policy limitations. If a loss is followed all the way through – the longer it takes a business to rebuild after an event, the more likely it is that business income losses will exceed the policy limit. As recovery times stretch, it’s also possible that they can extend beyond the period of indemnity. In addition, given the spike in costs, total building, equipment, and contents replacement costs may actually be underestimated, which can result in a company being underinsured or subject to coinsurance penalties.1
WHAT ARE THE CONSEQUENCES OF AN INACCURATE ITV?
Because property insurance premiums are generally based on the property’s value, many insureds seek to save money by under-reporting values. While that tactic can generate cost savings in the short term, it works against the long-term best interests of the insured. An inaccurate or artificially low ITV is also the primary cause of property claim litigation in the U.S. When policyholders undervalue their properties, public adjusters and attorneys generate demand limits post-event that are often in direct conflict with the insured’s chosen policy limits, leaving the client underinsured if it’s a total loss or dealing with unwanted coinsurance penalties. Subsequently, the ITV component of a property coverage submission is now one of the first things underwriters review, and it’s being scrutinized now more than ever.
In 2021, insurance policies are still being written with hard limits or clauses tying payment to reported values. For example, insurers may include a margin clause that limits an overall payout to 125% of reported values, especially when it comes to classes in harder markets like recycling, habitational, or high-hazard manufacturing. In the past, policyholders may have received recovery amounts well above stated values, but underwriters are now closely reviewing property values and cost estimates at every renewal.
HOW CAN AGENTS HELP?
Agents can help clients navigate value changes by taking a proactive approach to helping clients understand what they should do next.
Lead Proactive Client Discussions. Don’t wait. Make it a point to schedule mid-term meetings with clients to help set expectations well ahead of renewals. Add value for clients now by providing valuable information about how these changes can threaten a company’s viability. While a shortage of building materials and increased prices don’t directly affect insurance pricing, clients will see prices rise as they increase reported values and insurance limits to achieve adequate coverage. Unfortunately, it can be hard for policyholders to wrap their minds around the higher cost of rebuilding after a devastating event, and some are balking at increasing limits in favor of hoping they don’t experience a loss. Agents should do their best to explain the potential consequences of that choice and then complete due diligence by documenting client discussions and any declination of increased coverage.
Review Rebuilding Cost Estimates. Agents should help clients reassess their building, contents, and equipment replacement cost estimates, as well as business interruption coverage limits to ensure that adequate coverage is in place, should the rebuilding process take longer than anticipated.
Discuss Supply Chain Alternatives. The market for materials and labor is expected to remain under pressure for at least the next several months. However, if additional supply chain pressure results from natural disasters such as hurricanes, wildfires, or flooding, then the current state of the market will be even more prolonged. Agents should encourage clients to develop sourcing and procurement backup plans for materials, equipment, and resources.
Re-evaluate Policy Terms and Conditions. Clients and agents should collaborate to confirm that policies include appropriate policy limits and/or sub-limits so that policyholders don’t end up underinsured or hit with co-insurance penalties.1
Challenges around accurate ITV numbers and the cost of materials and labor aren’t impacting a few select classes of business. These changes are impacting property business all across the board, making it vital that agents have tough conversations about how rising costs can threaten a business and impact insurance needs. Then, start the renewal process 90-120 days out to allow enough time for the risk to be properly marketed. Submissions should include an ITV based on square footage vs. limit as well as a current appraisal.
CRC Group is home to some of the best property brokers in the business. Allies with longstanding market relationships, CRC’s brokers take their consultative roles seriously. Agents and their clients can depend on our team to bring up and address current market issues and emerging threats that can make or break a business when the unexpected happens. Contact your local CRC producer to learn more about how we can help find the right solution for your property business.
- Phil Adams is the Florida Regional Director for CRC Binding and President of the CRC Orlando office where he and his team specialize in placing a wide variety of Property risks.
- Insurance Implications of Rising Building Costs, Insurance Journal, June 14, 2021. https://www.insurancejournal.com/blogs/the-hanover/2021/06/14/618400.htm
- Why Are Insurance Premiums Rising? Bremer Bank, December 23, 2020. https://www.bremer.com/insights/personal/2020-12-23-why-are-insurance-premiums-rising
- Steel Prices Continue to Set New Record Highs Week After Week, The Fabricator, March 18, 2021. https://www.thefabricator.com/thefabricator/blog/metalsmaterials/steel-prices-continue-to-set-new-record-highs-week-after-week
- Construction Costs Are Skyrocketing—Should You Build A House?, Forbes Advisor, May 20, 2021. https://www.forbes.com/advisor/mortgages/should-you-build-a-house/