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ROI is more obvious for some investments than others, but please understand: not investing the time to ensure declared values are accurate may jeopardize the very resilience you’re trying to achieve in the first place. You may find yourself underinsured, underserviced or ill-advised, all leading to ineffective enterprise risk management.
The commercial property insurance industry is experiencing an epidemic of underreported values. Too often declared values of x are found to cost 1.5x or 2x to make the operation whole after a fire, flood or extreme weather event. The lower declared value likely originated while preparing the budget. The incremental YoY change in values was in line with other costs so they must be right…right?
At first glance, this sounds like the insurer’s problem because the claim – even if larger than expected relative to reported values – is covered. And the resulting poor loss ratio? Well, the premium shortfall will be recouped one way or another (e.g., through industry-wide rate increases). Insurance works best for everyone, policyholder and insurer, when declared values are accurate.
So why are values underreported? A cynic might say it was to contain cost but that’s not my view. There are other, more guileless reasons.
Your business value is more than your accounting records might show
The first is inertia. An organization may have for years purchased a specific policy limit (say, $500 million) so it just keeps doing it. The amount of coverage to purchase was previously agreed at all levels of management so the annual reporting process isn’t used to confirm it remains appropriate. This practice obviously fails to reflect how the business has changed, the new value that has been created since the decision was taken or the effect of inflation.
The second common reason companies underreport values is they rely on accounting records. The balance sheet asset value, or acquisition cost of a new division, do not represent what it will take to replace the plant and equipment today or the performance of the business. Although a property was purchased for $150 million dollars it may cost much more to rebuild tomorrow after it has burned to the ground and even more to replace the business income you lose while rebuilding.
Consider having to replace a manufacturing site built 15 years ago. The cost today is much higher, not to mention the lost revenue over the next 18 months while it is being rebuilt. To protect yourself, you need to cover the whole risk, plan for it, prioritize it, and manage it.
Another example would be a nationwide retailer whose revenue soared during the pandemic lockdown because it aggressively transitioned to omni-channel sales with curbside pickup. While the business’s value escalated, its commercial property footprint stayed the same. The expiring coverage was based on the old business model. Yet if a key distribution center was destroyed in an earthquake, the insurance would fall short of the new, much higher level of revenue. The business would be underinsured and there’s a good chance customers don’t return when the shelves are stocked again.
It’s good to be right
Adequate coverage, however, isn’t the only reason why your staff should invest the time to develop accurate values. Importantly, CFOs will see a return on the effort:
- Understand their risk. With accurate values, you have solid, objective data to conclusively determine which facilities are most critical to the performance of your business.
- Manage the risk. You’ve defined your tolerance for risk but it’s impossible to manage enterprise risk when you haven’t accurately quantified it. If you don’t know the true and total cost of losing a facility for an extended period of time, you’re just guessing.
- Prioritize risk improvement. You have a finite capital budget. Accurate risk quantification is essential for deciding how to prioritize expenditures to mitigate enterprise risk.
- Represent the risk. Your insurer is a partner in your risk management function. Underwriters rely on the policyholder’s report of values to deploy capacity. Correct values are critical to an insurer’s ability to operate within its risk appetite.
Accurate values are the raw materials of insurance, and insurance underpins a sound risk management program that keeps you resilient, mitigates disruption and ensures you recover as quickly as possible.
A catastrophe is the wrong time to discover you got it wrong.
Jeffrey J. Beauman is staff senior vice president and chief underwriter at FM Global.