In this Opinion piece, Rebecca Fuller, Managing Director, Valuation Advisory at Duff & Phelps, looks at the problem of under-insurance and how to solve it. The days of getting a rebuild valuation done once, and then simply bumping it up a few percentage points every renewal date, are long gone. It’s time to regulate – seriously.
The problem of underinsurance in the commercial property insurance markets is widely recognised –and just as widely ignored. It’s a common complaint throughout the industry among both insurers and brokers. But so, too, is the weather. While you can’t do anything about the latter, the former is, in fact, easily addressed by regular valuations – and yet this is largely ignored. The evidence strongly suggests that if it is going to be addressed, something needs to change. That change could be regulation.
The insurance industry is already extremely heavily regulated, of course, but this makes the silence over valuations even more glaring.
That’s most striking when it comes to the Insurance Act. What can be said of the customer’s duty to make a “fair presentation of the risk,” for example, when there is such uncertainty as to something so fundamental as the value of property at risk? How can customers be said to be disclosing “every material circumstance” when that doubt remains? And, given the recognition of widespread problems in this respect in the market, should not a prudent insurer be “on notice” of the risk of underinsurance if no evidence of a recent valuation is provided?
Perhaps more seriously, we should probably be asking if an insurer can really be treating customers fairly in these cases: if it is content to be complicit with a state of affairs in which businesses may be overpaying premiums if over-insured or putting their very survival at risk if underinsured.
A no-win situation
It is in everyone’s interests to tackle this problem. The failure to get regular valuations and consequent risks of underinsurance benefit neither the insurer nor insured.
Most obviously, businesses suffer in the event of a claim. In the very best case, if the insurer pays up to the sum insured for damage to buildings and equipment, businesses will be left with a shortfall against the costs of rebuilding or replacement. With underinsurance often close to 20% or much more, many small and medium-sized businesses without big cash reserves face bankruptcy. Those that continue will see the resulting disputes delaying resolution of their claims.
However, there are significant costs for insurers, too. To begin with, there is the lost revenue from the premiums they would be charging for higher sums insured were valuations accurate. In the event of a claim, meanwhile, they face a quandary: In a soft market and for important clients they are likely to feel pressure – from brokers, if not themselves – to simply pay up to the sum insured. For customers who aren’t key or big losses, insurance providers will have to commit to weeks of wrangling, costing time and money, to try and negotiate the payment. That’s particularly true since “average” clauses, reducing payments across claims in proportion to the level of underinsurance, have been excised from so many contracts.
Certainly, following the Insurance Act, they cannot avoid liability entirely, and must come to some sort of reasonable settlement with businesses suffering a loss.
The incentive to tackle the problem of underinsurance, then, and commit to independent valuations and regular reappraisals should be strong on both sides. And yet, far too often, nothing is done.
Head in the sand
There are probably several reasons for that. The first is that customers assume they are fully insured. They may rely on market values rather than rebuilding costs (including removal of debris and land clearance), for property or reinstatement for equipment, for instance. In many other cases initially, accurate valuations drift over time, either because they are not adjusted at all or, more commonly, they are uplifted according to an inappropriate or simply inaccurate index.
At the same time, there’s often reluctance to commit to independent valuations. In many cases that’s down to the perceived cost or the fear of disruption to the business from time required to enable valuers to assess the site, buildings and equipment.
These fears are increasingly unfounded. Modern technology has markedly enhanced the speed and efficiency of valuations, with valuers able to draw on the mass of data available online and in-house from open and specialist sources to hugely reduce the time required on site and costs to businesses. To help clients with these issues, Duff & Phelps uses proprietary technology to scan and analyse large property portfolios to highlight those in need of a valuation, and those that can safely be left for the future.
Our solution benchmarks insured values based upon extensive, global data collected by Duff & Phelps, the world’s largest independent valuation provider. In some ways, this reality does not matter, though: As long as the perception that valuation is both expensive and burdensome persists, there will always be the temptation to do without.
And perception is key: Perhaps the biggest issue is simply that, for all the talk, there’s a lack of hard facts when it comes to underinsurance in this area. Businesses and insurers rarely wish to battle it out in court, so there’s little publicly available information. The oft-quoted research from the RICS’ Building Cost Information Service (BCIS), which found 80% of commercial property is underinsured, is largely all we have to go on. And that dates from 2012.
Again, this may be something technology can help address: With data captured by Duff & Phelps –currently used exclusively by AXA Insurance Business Resilience Managers to assist their clients approximately 5,000 times a year – we can begin to build a real picture of the levels of underinsurance in the UK. For now, though, there’s little empirical evidence; it’s all anecdotal. That makes it all too easy for businesses to think it will never happen to them.
Cruel to be kind
Even in light of all this, a call for regulation isn’t going to be popular with everyone. As Ronald Reagan joked, “The most terrifying words in the English language are: I’m from the government and I’m here to help.”
In this case, though, regulation would really help both insurers and their customers. That includes SMEs. In fact, it’s particularly true for them: They are, first, less likely to benefit from insurers choosing to accommodate their oversight and pay fully up to sums insured; and they are the least able to bear the cost of underinsurance if the worst happens. Regulating valuations can help to protect SMEs from exposure due to an existential threat. Specifically, for the dwindling numbers of small industrial businesses in the UK, this could prove a key policy.
For insurers, meanwhile, tackling this problem once and for all would help close the insurance gap, and provide greater certainty for themselves and their customers, preventing disputes.
Already some countries have taken concrete steps to address this. Since April 1, 2016, in Saudi Arabia, for instance, businesses with property policies written by locally-licensed insurance companies must have a professional insurance valuation report that does not exceed three years in age. In Italy, meanwhile, there is no regulation, but “insurance with declaration of value” policies are widely used. These require an appraisal of the assets to indicate the correct value to be insured.
In the UK, though – where the market is beset with regulation in so many other areas – the problem is allowed to fester. Insurers and businesses have proved unable to tackle this themselves; it’s time the regulators stepped in. This can help promote a fairer, stronger commercial property insurance market for everyone.