The recent surge in inflation across the economy has impacted the price builders must pay for various forms of insurance. Simply stated, rising costs mean potential claims are worth more, and insurance companies must charge more to assume this risk. From an insurance company’s standpoint, they need to anticipate far more contingencies than they would have in a non-inflationary environment. It is crucial that insurance companies appropriately price this added risk because they could be left paying claims without the necessary financial reserves to afford them.
Shortages of Workers and Supplies Are Causing Inflationary Spikes
There are numerous factors that have caused the recent inflationary environment in which the economy finds itself. One of the chief reasons is that there is a labor shortage throughout the economy. COVID-19 took millions of workers out of the workforce, and companies have scrambled to find enough staffing. The construction industry has not been spared by these pressures. Arguably, the industry has been hit harder than most because industry jobs have been chronically understaffed. In addition, the supply chain crisis has meant that building materials are in short supply, so construction companies have been forced to pay more for those materials. Finally, a sustained period of low interest rates (which is now over) resulted in sharply escalating property values and an insatiable demand for construction projects.
Why Workers’ Compensation Premiums Are Steadily Increasing
One of the major drivers of insurance cost increases for construction companies is higher workers’ compensation premiums. In the first six months of 2022 alone, workers’ compensation premiums increased an average of 10.1%. These premium increases have outpaced the rate of inflation.
There are a number of factors that have caused the sharp spike in premiums, including:
- Workplace safety has been affected by COVID-19, leading to more claims
- Staffing shortages mean construction companies have had to hire employees who may be less qualified, leading to more workplace accidents
- Medical costs have increased along with the prices of practically everything else in the economy
- Construction companies have had to pay higher wages, so the lost wages component of workers’ compensation claims has become more expensive to pay
Inflation May Mean that Commercial Builders and Property Owners Are Underinsured
Commercial businesses often do not have enough insurance to cover casualty and damage to their property. The increase in construction costs and property values means that many companies may not have enough coverage for the replacement value or repairs to a building that is damaged. Building materials such as lumber and copper have more than doubled in price since the start of the pandemic.
In addition, the same staffing shortages that have caused spikes in workers’ compensation insurance rates are also leading to higher construction costs. Builders are struggling to find enough employees to staff projects, and they have been forced to pay higher wages. They are then forced to pass along these higher costs to their customers.
Insurance Companies Should Exercise Extra Care in This Environment
Insurance companies must consider these factors in pricing premiums. Not only must they consider the current inflationary environment, they must use a dynamic model to account for what inflation may be in the future. Although the Federal Reserve is waging a battle to bring inflation under control, there is no guarantee that the Fed can rein it in to its historical target. As a result, an insurance company may end up paying for a repair that costs far more than what was factored into its model when it priced the premiums.
The current economy poses numerous challenges to underwriters. There are far more uncertainties than there are in a lower inflationary environment. The volatility could cause significant fluctuations in numerous inputs to an insurance claim. Insurance companies must do what seems virtually impossible: anticipate everything that could cause claim valuations to increase. If underwriters make any mistakes, they may have to draw down reserves to pay claims. If this happens too often, they will drain their reserves.
The inflationary environment may cause additional difficulties for insurance companies. Scarcity and delays in obtaining building materials could add additional time to the claims process, as insurance companies attempt to calculate the value of the claim. However, under the law, insurance companies do not have an unlimited amount of time to make a settlement offer. They may find themselves facing fines or penalties if they unreasonably delay responding to a claim.
How Insurers Should Deal with the Inflationary Environment
Insurance companies could do the following to respond to the current economic circumstances:
- Focus their product offerings on shorter duration policies, charging increased premiums if commercial customers want longer arrangements
- Limit some of their own risk by purchasing reinsurance
- Challenge and change many of their own assumptions about the potential direction of prices
Current Insurance Challenges for Commercial Businesses
Commercial businesses face their own risks when procuring insurance in this environment. If they have taken out a multi-year policy, they may not be protected against increases in building costs and repairs. They may have insured their building based on an older valuation that does not reflect an increase in the value of the property or how much it may cost to repair it. In general, commercial businesses should consider an automatic inflation adjustment to their policies that increases at a certain rate every year or quarter.
Businesses could do the following to manage their own insurance-related risks present in today’s economic conditions:
- Consult with an insurance broker to ensure they have sufficient insurance coverage in various scenarios
- Increase their periodic policy reviews to account for changing conditions
- Negotiate with insurance carriers if they need specialized coverage provisions for their particular circumstances
- Continuously review policy limitations and exclusions in coverage and consider purchasing additional insurance to cover what may otherwise be excluded
Insurance Coverage Attorneys
Williams Kastner has represented insurance companies in Oregon, Washington, and across the nation. We advise clients on complex policy application and interpretation issues and represent insurance companies in all types of insurance coverage disputes. Our legal team is well known throughout the insurance industry for its track record of delivering reliable legal advice on demand.