Insurance Pricing and Risks: The Impact of the Economic Climate and Increases in Unoccupied Commercial Properties

Economic volatility has a profound impact on the property market and in unusual financial climates, insurers and brokers must navigate uncharted waters. In this article, we review the UK and global economic outlook and how the property and insurance sectors are expected to be affected. We also review specifically how this will impact the commercial property insurance market and discuss emerging risks and market changes.

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The global financial outlook

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The global economic outlook is predicted to be subdued as we head into 2024, rather than lurching into the global recession that has been looming on the horizon throughout the last year. Weaknesses in global housing, bank lending and the industrial sector have been offset by strengths in other areas, including service-sector activities.

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Recent data has led to a forecasted GDP growth of 2.9% in 2023, down from 3.3% in 2022. A further slowing to 2.5% is expected in 2024, with growth set to be strongest in Asia, while weakest in the US and Europe.

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JP Morgan recently published their mid-year outlook, in which they warn of the probability of a recession for the UK and US economies in 2024. They also highlight the slowing down of business investment and the positive offset of consumer spending.

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Across the wider global economic outlook, growth is moderating in times of high inflation and monetary policy tightening.

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The UK economic outlook

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The widely predicted UK recession of 2023 is yet to materialise, with the UK instead experiencing a prolonged period of teetering on the edge of economic decline. The data doesn't bode well for both the UK and global economies as it points towards a recession in 2024.

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With that in mind, the focus appears to be more on assets than unemployment, with the labour market remaining surprisingly resilient. Asset-rich individuals and finance companies are wary of how volatility will impact valuations and portfolios.

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What are the drivers behind premium levels increasing?

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One of the key drivers behind premium levels increasing is the indexation adjustment based on high inflation in the UK. Inflation is affecting sums insured and financial estimates, enabling insurers to achieve overall premium increases without applying significant rate changes.

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Rating pressure in 2023 is partly driven from Treaty reinsurance renewals, with higher priced Facultative reinsurance. Insurers are increasingly offering decelerating rate increases for property with high quality risk management and low inception hazard.

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Commercial insurance underwriters are applying stricter criteria and higher pricing for less attractive customers such as social housing, care homes and hotels, where fire and escape of water claim losses have been experienced on a grand scale.

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Another type of risk that insurers are applying rate increases onto is buildings of combustible construction. This is impacting industries such as warehousing and food, where unapproved composite panels are commonly used in building construction for temperature control.

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This type of building construction, using combustible construction panels has been involved in many of the high-profile fire losses and insurance companies have subsequently increased rates to minimise fire claim losses. Higher inception hazard trades including plastics, timber, chemicals and waste are also risks that insurers want to avoid.

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The recent scandal involving RAAC concrete found in schools is also likely to drive existing rates up. The Reinforced Autoclaved Aerated Concrete has been identified in over 170 schools so far. Further investigations are underway to see if the unreliable concrete is also used in hospitals and other public buildings.

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Insurers are trying to achieve a balance between managing the most prevalent risks that cause the biggest insurance claims, while also attracting new business and retaining the customers who generate the bulk of the profits.

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Many insurers have started to challenge their own risk appetites and underwriting criteria in recent years as they look to protect their market share. The relationship between insurers and brokers has also become an area of focus, with the market-leading insurers looking to trade with brokers that they trust.

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Business closures lead to increased numbers of unoccupied commercial properties

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Commercial unoccupied property insurance is another high-risk property type that is becoming a bigger concern for insurers. There were more than 105,000 business closures in the UK in the first quarter of 2023, while only 79,000 were created, representing the largest net decrease on record. Some of these closures are attributed to businesses being signed onto fixed rate energy prices arranged when energy prices were at the peak, as recommended by the government.

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Inflation in manufacturing, materials and transport, along with rising cost of staff wages have also contributed towards business closures. Business closures result in high numbers of unoccupied commercial properties and insurers are now facing the added challenge of correctly pricing unoccupied commercial properties, which are at higher risk of escape of water, property damage and vandalism claims.

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Many businesses are tied into long-term leases for their premises, so commercial properties of closed-down businesses can stay unoccupied for a long period of time. Insurers looking for growth opportunities can provide specialist insurance cover for unoccupied commercial property, due to the increase in demand for this type of product.

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Interest rates, affordability and under-insurance

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As interest rates peak at 5.25% and the future volatility of rates remains uncertain, there is a growing concern about the affordability of insurance.

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The dynamics are not that dissimilar for residential and commercial unoccupied properties. For individuals and sole traders, the cost-of-living crisis and high interest rates are leaving many insurance policyholders struggling to afford higher energy bills and mortgage payments. To then add higher insurance premiums into the equation, residential property insurance policyholders may be more inclined to shop around and find the cheapest insurance cover on the market, which may not provide the most adequate coverage.

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Businesses who own their commercial property premises face a similar conundrum. With many businesses having already navigated financial difficulty throughout the pandemic and the subsequent repercussions, they are now facing increased labour costs, higher cost materials/equipment and higher energy bills. For insurers to then increase the commercial buildings insurance, this could push businesses too far, as they will be compelled to search for other alternatives, resulting in much higher levels of business re-broking.

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Claims costs for property owners’ insurance have risen significantly in the last 10-20 years, while premiums, until more recently, have largely remained the same. Property damage claims and business interruption claims are higher than usual, with more frequent weather events, high risk construction methods and escape of water claims all causing financial problems for insurance companies.

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Over the last 12 months, the market has seen index-linking increases of 18% for residential and 10-15% for commercial properties to address the issue of property under-insurance and rebuild values going up.

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The increase in property values and rebuilding costs mean that sum insured re-evaluation is critical to protect both commercial and residential property owners’ assets. For commercial property, where property values are on average, significantly higher than residential values, under-insurance is an even bigger concern.

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Sum insured re-evaluation should be a top priority for commercial property owners to ensure cover is adequate in the event of a fire or other type of severe building damage that requires a total or significant rebuild. This is also a high priority for brokers who are tasked with finding an affordable insurance policy for their clients, while ensuring that the sum insured is adequate.

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Where re-evaluation is not taking place, policyholders risk the possibility of receiving a lower-than-expected claim payout for rebuilding.

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With all these challenges to mitigate, insurers now face the difficult task of achieving the right pricing to maintain adequate numbers of policy renewals.

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Property owners’ insurance: the cost to rebuild and its significance

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Rebuild costs are a crucial calculation for both the insurer and the policyholder. Many policyholders mistake property market value as being the sum insured figure for buildings insurance. This does not cover the financial costs involved for rebuilding the entire property, which could be required in a total loss caused by a fire, for example.

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The rebuild cost of a property is likely to be lower than the market property value. Most properties that are made from standard materials and do not have any special design or architectural features can be rebuilt for significantly less than the market property value.

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Rebuild costs may include demolition, site clearance, professional fees for architects and construction as well as materials. In the UK, we have seen rising costs of building materials and labour costs that result in an increase in rebuild costs. Due to this, insurers must stay up to date with the latest fluctuations in materials and rebuild costs. This also applies to brokers to be able to find adequate cover that does not result in under-insurance for their clients.

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With commercial unoccupied property being higher risk, increased rebuild costs must be accurately calculated to price policies correctly without exposing the owners to losses.

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Conclusion

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The insurance market is in a very unusual situation. The combination of high inflation and interest rates putting increased financial pressure on households and businesses means insurance affordability is a delicate balance to achieve.

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With an influx of emerging risks such as high-risk building construction materials and an increased number of business closures, insurers must be vigilant with underwriting criteria and premium increases to effectively manage these risks.

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A stronger focus on avoiding under-insurance should be a priority for insurers and brokers to ensure that escalating material and labour costs are factored into sum-insured calculations.

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While the financial outlook is uncertain with new challenges for insurers to overcome, there are also new opportunities available such as providing specialist cover for unoccupied property insurance and gaining market share in this growing area.