With inflation on the rise, it is understandable that policyholders are inquiring how this will affect their policy. Inflation guard and insurance to value are both important factors to educate your agents on so they can advise their policyholders accordingly. They each are crucial to property coverage policies but take on different purposes.
Inflation Guard (Building Limit – Automatic Increase)
Inflation guard coverage is a policy provision that gradually and continuously increases the limit of insurance by a specific percentage over time during the policy term. It automatically increases the building coverage limit by the selected percentage over policy days to help keep up with inflation that occurs during the policy period. It is one of the solutions to counter increases in cost due to inflation.
Insurance to Value (ITV)
Insurance to value (ITV) is an amount approximating the value of the actual replacement cost of the insured property. ITV affects the stated policy limit. It should not be confused with a policy provision. It refers specifically to the cost to replace or repair the property, whereas the inflation guard is a policy provision.
Proper Limits & Payouts
CPP policies and BOP policies vary for ITV. BOP policies are based on 100% building replacement value as the limit of insurance, whereas CPP policies can have different limits depending on the selected coinsurance percentage. Limits should accurately reflect the true loss potential to ensure proper payout in case of a claim without a coinsurance penalty. Proper limits help to avoid having an unhappy policyholder, reduce and eliminate the potential moral hazard, and generate higher premiums thereby creating a larger pool of premiums with better data credibility, and allowing for lower premium rates at the product level.
Inflation Guard and Inflation to Value In Action
As an example, let’s say you have an agent with a client with a building limit of $10,000,000 and the inflation guard was set at 5% for this policy. If the policy was renewed and a 6% ITV was applied to the policy limit, the building limit would now be $10,600,000 with the inflation guard remaining the same. In a hyper-inflation market, where inflation averaged 10%, the insured would face increasing underinsurance if the inflation guard was set lower, even if the coverage limit was proper as of the policy effective date. In this example, even if we assume the limit of $10,600,000 was correct, the insured would be underinsured by $265,000 at the mid-point of the policy if the actual inflation was 10%. It is in the best interest of the insured to set an inflation guard to match the anticipated inflation rate, so they do not face underinsurance as the policy matures.
If you are helping an agent who has a business customer with a new policy, inflation guard and insurance to value are topics you will want to consider discussing with said agent. At Topa Insurance, we want and encourage your agents to review coverage limits and inflation guard percentage at least annually.
Interested in learning more about how Topa Insurance can help you and your clients with inflation guard & insurance to value? Please contact:
Assistant Vice President, Product Management