Right now, inflation in the UK is at an all-time 40 year high, standing at 10.1% in January 2023⁽¹⁾. Inflation is the general increase in the price of goods and services alongside a complimentary reduction in the purchasing power of money⁽²⁾. While inflation itself is not inherently good or bad, rapidly increasing inflation can cause economic stress on individual, social and corporate levels. Right now it’s having an impact on insurance and the cost of settling claims.
What is Claims Inflation?
When Insurers calculate the premium value, one of the components of the calculation is based on an index applied to the value of goods each year.
Claims inflation is the increase in the amount it would cost to settle an insurance claim.
Because of the increasing costs in labour, materials and energy, it costs significantly more to repair, replace and rebuild than it did at a lower inflation level. Further, where there are delays in finding appropriate labour, sourcing and delivering raw materials and parts, and/ or longer business interruption, this further exacerbates claims inflation.
As Insurers are having to pay more in claims, the index used to calculate the premium has also gone up and therefore premiums are also on the rise. Insurers need to cover the current cost of repair, replacement, materials, parts, labour and energy.
How does inflation affect the claims process in the commercial property market?
The increased price of parts, materials, labour, and energy forces the cost of reinstatement after loss to increase.
Claims Inflation Statistics (2022):
Underwriting inflation increased by 13%
Rebuilding cost inflation increased by 9.6%
UK construction costs reached 40-year maximum
Construction vacancies stood at 45,000 compared to 42,000 in 2021
An additional 266,000 construction resources are needed to match demand
Rebuilding material inflation increased to 20.3% (73% sawn wood, 60% steel, 10% paint, 28%, bricks, 15% cement, 10% timber)
Water damage claims increased by 20%⁽³⁾
Specifically within the commercial property market, supply chain disruption and a shortage of skilled labour continues to affect building repair costs, causing significant delays to the completion of work. Not only is the impact of the loss felt for longer, it also affects the quality of life for the Insured as repair work often dictates alternative accommodation solutions⁽⁴⁾.
The impact of claims inflation is fairly instantaneous with many recent commercial claims featuring a capacious gap between the Insured’s declared value, and the value of reinstatement. One claim submitted after the 2021 Colorado wildfires featured a rebuild value double that of the declared value. The rising national inflation and sudden outpouring of demands surcharged reinstatement costs, forcing the Insured and Insurer into economic disagreement.
Managing and mitigating claims inflation with IoT technology-solutions
Is the adoption of IoT devices, and the use of real-time data a way to mitigate claim inflation? IoT-based technology can generate an improved grasp of client needs, as well as collect and assess data for comprehensive risk evaluation before losses occur⁽⁵⁾.
Preventative Maintenance
IoT devices have machine learning and real-time data collection capabilities that permit the collection of large amounts of granular data across a variety of parameters. This data can then be used to generate accurate risk models for the prediction of future losses. If an insurer can better predict when and how a loss will occur, preventive measures can be taken to minimise the impact of that loss. This will drive down reinstatement costs⁽⁵⁾. The earlier this intervention is, the lower the overall cost of that premiums are to be⁽⁴⁾. Indeed predictions become more accurate as the base of data to which assumptions are applied increases. Furthermore, data can be used to identify alternative, cost-effective replacement materials. By applying IoT data to risk management insurers can proactively adjust hazards and perils ahead of time to mitigate claims inflation.
This is known as preventative maintenance, and it alleviates the risk of significant incidents and machinery breakdown. As such, major business interruptions are avoided, repair and replace expenses and costly downtime are minimised.
The core of commercial insurance is the pricing of risks⁽³⁾. The exchange of IoT data could be used to automatically monitor and adjust the value of assets and the cost of replacement. This may prevent unexpected increases upon policy renewal, ensuring that policyholders are always fully reimbursed post-loss⁽⁵⁾. In addition, claims leaders can use IoT to track key data on management dashboards including:
Underlying Inflation
Claims Composition
Risk Mix
Policy Changes – changes in policy distribution, such as the increase in comprehensive policies attribute about 1-3% to the rise in claims costs⁽⁶⁾.
By monitoring this vast range of granular data with IoT, Insurers and claims experts can make more informed decisions. IoT permits data to be shared between claims, actuarial, pricing and underwriting, meaning inflation is monitored at every level of the insurance process⁽³⁾. Thus, IoT facilitates dialogue between parties encouraging strong relationships that can be utilised to mitigate claims inflation in multiple different fractions.
Additionally, preventative maintenance is good risk management behaviour. Insureds who embrace preventative maintenance through IoT technology will be more attractive to Insurers because they are able to drive discussions on more favourable terms and conditions. And, at the point of claim, the more detail that can be provided about a claim quickly, the better and faster the Insurer can intervene and the greater the potential to minimise costs⁽⁸⁾. Indeed, could the Insurer know about the claim, fix or pay, before the Insured?
An example in context - Improved Cat Modelling
Cat modelling is used to build comprehensive pictures of catastrophes resulting in commercial losses, for example high resolution risk-based flood rating models. Cat modelling is one example in which the above discussions can be put into context.
Biometric and environmental sensors could be used to calculate risk points and adjust policies as the situation changes in real-time. This includes climate change effects, urban development, granular micro data, data on building structures and material cost⁽⁷⁾. Better model prediction on what type of catastrophes may occur and when and what type of damage could be expected, permits insurers to implement preventive stances ahead of loss. For example, the purchasing of more specific-catastrophe-resistant materials to build with.
Fraud and How to Fight It
One of the biggest and most unexpected challenges to come from rising claims inflation is an increase in fraud. It is predicted that customers are adding 25% to the top of their claims to push up the price in a personal attempt to avoid underinsurance.
Fortunately IoT is here to help! To counteract fraud, some Insurers are introducing pre-photographs to survey a customer’s property prior to bind. This will identify any pre-existing issues that the insured may try to falsely claim against. IoT can expand this approach by continually monitoring the property throughout the year and providing detailed metadata that can objectively support or dispute a claim. Additionally, IoT technology can scan documents to ensure they haven’t been tampered with, examine a customer’s financial background, and monitor their internet fingerprint for suspicious behaviour. Insurers can then share this data between companies to help identify difficult customers or train employees to handle fraud and associated documentation⁽³⁾.
Example: Satellite and IoT – Parametric Insurance and Fraud Detection
A factory in Italy made a claim stating 60% damage to a roof due to hail. Traditionally, an insurer would have to send out a loss adjuster and there would be a delay in settling for the client. In this case the insurer was able to access an IoT weather sensor within 0.5km of the site and this demonstrated that the temperature (on the day claimed) had dropped consistent with hail. Additionally, the insurer was able to access satellite imagery from a day after the event that also showed the damage claimed. However, when they analysed satellite imagery from a few days before the claim, they saw that the damage was pre-existing and further satellite image analysis showed it was caused a month earlier by undeclared activity and so demonstrated a fraudulent claim.
Conclusions
Current inflation rates are dramatically driving up the costs of commercial materials and labour. As such, upon renewal of policies the insured cannot be reinstated to an equal position prior to loss. Therefore, claims are heavily inflated and the insured is underinsured. Use of IoT devices permits the detection and categorisation of risks before the loss occurs, this allows preventative maintenance of risks. Consequently, there will be less to replace or repair afterwards, this helps to ensure the contractual amount for the cost of the premium remains sufficient to reinstate the insured upon renewal. IoT can help to control fraud and monitor trends to predict future issues. This effectively mitigates claims inflation on several granular levels and ensures this information is shared to everyone in the insurance process.
References
1: Wikipedia., Inflation - Wikipedia
2: BBC News., (2023) What is the UK inflation rate and why is the cost of living rising? - BBC News
3: Dilmegani, C., (2023) 6 Ways IoT will Change the Insurance Sector in 2023 (aimultiple.com)
4: Gallagher., (2022) Claims inflation: Why are claims costs rising? | Gallagher UK (ajg.com)
5: Bairu, H., (2023) Managing inflation risk on both sides of the balance sheet (insiderengage.com)
6: Johansson, S., et al, IoT in the insurance industry: Commercial lines | McKinsey
7: Morgan, B., (2018) Here's How IOT Will Impact The Insurance Claims Process (forbes.com)
8: Towergate Insurance Brokers., (2023) What Claims Inflation Means For You in 2023 - Towergate Insurance Brokers