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Persistent, elevated inflation rates are driving up property costs

January 20, 2023

Although the pace of inflation has moderated recently, the country is still experiencing rates not seen in decades. Consumers, businesses and insurers alike have been affected by pressures caused by the current market environment.

From an insurance perspective, one of the biggest questions in front of agents and policyholders is if adequate coverage for commercial property is in place.

This question looms large in part due to the largest spike in construction material costs since 19701 and pandemic-related supply chain issues. Meanwhile, historic weather severity, inflation, and continuing interest rate hikes2 are driving up costs related to maintaining and repairing properties.

This article offers insight into the factors driving inflation and its impact on commercial property coverage. It also provides steps policyholders can take to ensure their policy is keeping pace with the shifting landscape.

Factors driving inflation and construction costs

There has been a confluence of factors driving inflation and construction costs, which results in large impacts to property reconstruction costs. Learn more about what’s influencing inflation.

View the infographic

  • Worker shortages. Across the board, labor shortages have been the norm for employers recently. With an elevated level of 10.3 million job openings, the U.S. is still down about 4 million workers compared with pre-pandemic levels.3 As an example, the construction industry needs to attract nearly 440,000 additional workers on top of the normal pace of hiring in 2022 to meet the demand for labor. With many construction jobs remaining vacant across the U.S., the shortfall is causing project delays and driving up costs.4
  • Supply chain disruptions. Inflation has remained high due to both COVID-related supply disruptions and consumer demand outpacing inventory for many goods. Although supply chain issues have eased, 41% of businesses have increased prices as a result of supply chain bottlenecks5 and costs for many items remain at historic levels. While the backup of container ships at ports is less than it was in 2022, the ongoing shortage of truck drivers causes issues for getting goods to market.6 Furthering the concern, the ongoing shortage of computer chips has hampered goods reaching market and contributed to inflation.7
  • Raw material costs. Material costs skyrocketed in 2022, and some have remained elevated. Steel-mill products are nearly double from pre-pandemic levels8, lumber materials are up more than 40% from pre-pandemic levels and notably concrete prices have increased over the past year at the fastest rate in 34 years.5 These increases have made it more costly for businesses to rebuild or make repairs to their facilities and raises the importance of insuring commercial properties to value.
  • Increased frequency and severity of weather events. Over the past five years, there has been a 37 percent jump in billion-dollar disasters compared to 2000 to 2009, with 86 high-cost disasters in the past five years versus 63 occurring from 2000-2009. The total cost of billion-dollar disasters from 2017 to 2021 is $742.1 billion, or an average of $142.4 billion a year, triple the inflation-adjusted annual average for the previous 42-year period.9 Catastrophic weather events occurring at a record pace is putting underwriting pressure on insurers and pushing insurance premiums higher across the board.
  • Supply shock. A supply shock is created when an unexpected event changes the total supply of goods and services in a market, up or down. Typically, a supply shock is felt regionally. For example, a wildfire in California would typically put a strain on the area affected, with minimal impact to supply and demand surges elsewhere. Given the global impact of an uncertain economic environment, supply chain challenges and global unrest, supply shock is putting added strain on inflation.

Impact of inflation on commercial property insurance

Inflation has many direct impacts on commercial property insurance including, but not limited to:

  • Policyholder premiums. Amid elevated property loss costs, some insurers may experience poor underwriting results, which can lead to increased premium expenses and coverage restrictions. While most property policies have a provision that accounts for a small percentage of inflation, heightened repair and rebuilding costs can increase claim severity. This situation can cause potential underinsurance concerns following larger property losses.
  • Real property. Given the historic rise in the cost of construction materials and labor, if it cost $1 million dollars to replace a business’s real property last year, it might cost $1.2 million this year. Supply chain issues can also delay repairs and result in more expensive losses overall if the ability for a business to generate revenue is impacted. To avoid being underinsured, it’s important to confirm that replacement cost coverage is part of a policy and that the replacement cost estimate is up to date.
  • Business income. In light of current inflation rates, which can affect sales, wages and the amount of time to repair property, business income limits should be adequate to keep income flowing and avoid co-insurance penalties. While it’s critical to evaluate limits for real property, it’s also very important to evaluate adequate business income coverage limits and business continuity plans to help shorten any impact of loss.

Risk mitigation tips

Even with normal levels of inflation, proactive risk-management planning can lead to better business outcomes. The following steps can help manage risk and avoid out-of-pocket losses.

  • Review policy details and coverage limits. Considering rising construction and repair costs for commercial property, it is a good idea to review policy terms and conditions. It is also a good time to address issues that could impact coverage, such as how labor and supply shortages may affect estimated replacement costs.
  • Reassess property valuations. During inflationary periods, it is especially important to review property valuations annually to ensure coverage is keeping pace with labor and supply-costs. Detailed information on the covered property’s construction can impact the valuation. This review should include real property (buildings, pavement, land, plumbing, electrical, etc.), business personal property (such as furniture, machinery, supplies, tools, etc.) and business-income limits (loss of income or profits due to covered peril). Related to business income, it’s important to note that determining the amount of coverage to be paid under future lost income can be difficult to predict, so keeping accurate records of the prior year’s income and profit is important.
  • Implement risk management and loss control programs. A business continuity plan and tailored loss control programs are important to address specific risks the business may face. This includes an action plan for catastrophic disasters and/or the likelihood of the business being shut down, with procedures for what to do before, during and after a loss. Nationwide’s My Loss Control Services can be accessed for assistance in developing a business continuity plan along with other loss control resources to help manage risk. Loss Control Services consultants can help tailor solutions to meet specific risks faced by businesses.