Underinsurance: The risks posed by supply chain issues and material shortages

There is an old adage, often heard upon the existence of an insurance policy, along the lines of “it is okay, it is covered by the insurance”. This overly simplistic take is one that often fails to take into account all issues surrounding the scope and extent of any policy cover in place.

Perhaps this has never been more apparent than in the current economic climate where society and businesses alike are being impacted by supply chain shortages and increased prices for materials.

These factors have been significantly contributed to by both Brexit and the ongoing global COVID-19 pandemic. One needs to look no further than the recent lengthy queues at the petrol station forecourts to see the evidence of this.

But what does this mean for insurers, their suppliers, brokers and policyholders?

Underinsurance

One of the biggest risks presented by these particular issues is underinsurance. In the words of the Financial Conduct Authority: there is already “an alarming degree of underinsurance” for both UK businesses and consumers so there can be little doubt that this is a prevalent issue for insurers. 
 
As a starting point, it is the responsibility of policyholders and, in some instances, their brokers to ensure that they take out sufficient levels of cover for the insured risk when arranging a policy of insurance. A failure to do so can have devastating consequences for policyholders resulting in significant reductions in any insurance payments made, via the application of average clauses, and in the worst case scenario, may potentially even result in policy avoidance.

By way of practical example, imagine that the insured’s premises is destroyed by a large fire. If the rebuild cost of the premises is £200,00 but the insured has only insured them for £100,000, they will be underinsured by 50%. The effect of an average clause may therefore be to reduce the sum insured by 50% leaving the policyholder with an insurance payment of just £50,000. In these circumstances, any comment that the claim is “covered by the insurance” is clearly well wide of the mark and the insured could be left in a position whereby they are without any premises, and potentially out of business.

Whilst the example refers to the reinstatement of a building, underinsurance principles can apply equally to all insured losses. It is therefore critical that the cover levels taken out at inception and renewal accurately reflect the risk.

In real terms, reference to online calculators, market prices or using a “best guess” to estimate the true costs of the reinstatement of a property may not be sufficient at the best of times, but such an assessment is now made all the more difficult by the uncertainty created by Brexit and the pandemic.

Brexit & Covid-19 impacts

The UK’s decision to leave the EU has adversely affected the sourcing of materials and the available labour which had previously relied heavily on its ties to Europe. It stands to reason that any fall in value of the pound against the euro or the dollar is also going to result in increased costs for the importation of materials, plant and machinery.

The effect and impact of this has been exacerbated by the pandemic which has resulted in, amongst other things, the closure of a number of manufacturing plants. The need for individuals to isolate in certain circumstances has also reduced access to workers available to service any orders/work.

In short, the above is likely to result in delays in materials being produced and/or supplied, an increase in the costs of those materials and a lack of physical labour (including delivery drivers).

All of these issues have had, and will continue to have, a natural impact on the construction industry and in turn the insurance industry due to the increased time and costs necessary to repair and/or reinstate premises damaged by insured perils.

Not only are we seeing an increase in the cost of materials, the length of time necessary to effect the reinstatement of the properties is also increasing. This can have a knock on effect for additional elements of insurance cover, such as Business Interruption, and the adequacy of any insurance taken out to cover these losses.

On this subject, it is perhaps also worth highlighting the potential for insured businesses to stockpile goods in anticipation of issues associated with the supply chains. This can present its own risks of underinsurance with businesses having significantly more amounts of stock than they might ordinarily otherwise have, and more than they may have had (or expected to have) at the time of any policy inception. There then follows a secondary issue; how might the value of that stock have changed due to the economic climate?

What can be done?

Whilst there is little doubt that the well-publicised consequences of Brexit and the pandemic are well known to most within society and the insurance industry, the question arises: What is being done about it? How many policyholder’s can honestly say that their cover levels have been adjusted to reflect the risks identified above? The available statistics indicate that the answer to this question is: very few! 

The focus of this article is to highlight the critical need for an accurate assessment of adequate insurance levels prior to policy inception, mid-term and at policy renewal in the current social and economic climate.

From an insurer’s and broker’s perspective, it might be asked; what more can be done to highlight these risks to policyholders to ensure that: (a) accurate cover levels are taken out, (b) appropriate premiums are applied; and (c) to prevent issues of underinsurance?  Is it possible for insurers to provide clearer guidance to policyholders in respect of these risks at policy inception?

Last, but not least, there is the impact that all of these issues are having on active insurance claims. The loss adjuster’s job of assessing the losses immediately after the insured peril has occurred has  perhaps never been as important, or difficult, as it is now. It is important that loss adjusters take the issues of supply chain shortages and increased costs of materials into account in order to enable them to set accurate reserves for insurers at the outset of claims and to enable insurers to take all policy coverage issues into account.  

We specialise in policy coverage and indemnity issues, including underinsurance and can provide advice and expertise on these issues. 

This content was written by BLM prior to its merger with Clyde & Co.