Can Inflation Factors Help “Average Up” Your Book?

Part 2: Lecture Hall Lessons

All over the world, university students return home at the end of their first semester and reveal how their transition to higher education went. At that point they start to learn the importance of an “average” as in Grade Point Average. Some will go on to learn how hard it is to average up—increase the grade point average over 3-1/2 years to try to close in on a 4.0 GPA. The lesson some learn is that it is less work to start with and maintain a 3.0 than “average up” a 1.8 GPA. It is similar to the lesson some property insurers learned in 2021 and 2022 (or should have).

One lesson is underinsurance in a property portfolio can’t be “averaged up” easily. The answer to “How does one average up?” is simple—you don’t unless you have a lengthy time horizon and all else remains fixed. (Not to discourage any university freshman going into their second semester, a 1.8 GPA can be fixed. It is a long journey and lots of 4.0s are needed, but it is possible!) Just like the freshman, start with insurance-to-value for your book and it’s much easier to maintain and adjust for inflation.

How does inflation fit into this picture? We’ve all heard about inflation this past year and a half. Whether resulting from social changes, pandemic, supply-chain or some other cause, it has hit all over the world, especially financial markets, very hard. More directly, it has had a major impact on property insurance from lousy combined ratios to very expensive reinsurance renewals.

Wait! Is inflation really behind the current lousy combined ratios for property insurance? Yes, there have been some catastrophes. According to the Insurance Information Institute, the number of catastrophes has gone up, as well as the dollar amount in the past few years, but from 2012 to 2021 there are five years below the 10-year average and, therefore, five years above. The dollar amounts for the below average years are pretty far below average.

For a property portfolio, adding a 15% annual factor won’t help a 50% deficit. The other side of this is time. Unlike a college freshman, a carrier is not in a controlled environment. The world keeps happening. While adding 15% to a portfolio, the world could be adding 10% in costs. In the best scenario, instead of 50% off, it is only 45% off.

Sticking strictly to personal lines, where there is great independent data going back to 2007 on how property portfolios have performed, most personal property books are 50% lower than they should be. A group out of San Francisco, United Policyholders, has statistics on catastrophic losses from homeowners, 2007 through this year. Typically, more than 50% of the homes destroyed did not have enough coverage and typically it was off by 50%.

(Commercial losses are no better and for some, worse. We just don’t have a public facing database to share.)

Sure, inflation is causing an issue. More importantly, homeowners helped cause the issue. They renovated their homes once they started working at home after March 2020. Vacations and dinners out were out, interest rates were low, so why not renovate? Then the supply-chain broke down at the same time people could spend more money and actually mean, “I don’t care what it costs.”

Inflation just happened to highlight a flaw. The 20% price increases on home construction are magnified by a 50% error on the base. Meanwhile construction costs continued to rise, and inadequate inflation factors didn’t solve anything.

Conclusion: Analyze your portfolio. Find the bell curve in your book of business. Do a portfolio valuation. Once you have that information, resources, time and market constraints will dictate how to fix your portfolio. (You know, transfer to a new school and reset your GPA.) The key is to do something. It is not done in a vacuum and one way that is not recommended, is to non-renew the locations with the largest delta from current value to actual value.

The e2Value estimator tools were designed for high-value homes, Mainstreet® homes, condos, co-ops, commercial properties, manufactured homes, log cabins, farms and ranches. Our patented estimator can quickly calculate the cost of replacing a residential, commercial or farm structure and provide you with a fast, cost-effective and accurate replacement cost valuation. Contact us for more information.

See Part 1: What’s Wrong with Using Averages?