In property insurance, insurers typically adjust pricing based on an average annual increase of 4.5% to account for reconstruction costs. According to the CEO of Opta Informational Intelligence, this indexing measure no longer adequately considers the impact of inflation. This gap exacerbates the issue of insufficient insurable values.
During an interview with Insurance Portal, Greg McCutcheon shared the efforts he's leading as the CEO of Opta to raise awareness among brokers and insurers about inflation's impact on pricing for residential or commercial property insurance.
McCutcheon has already presented to broker groups in several provinces and hopes to soon do the same in Quebec.
Inflation
Inflation pressures hit globally in 2022, and Canada was no exception, he notes. In June 2022, the Consumer Price Index reached 8.1% on an annual basis, the highest rate in 39 years.
As a result, commercial building construction costs increased by 12.5% in 2022, the highest rise since 1981. Opta also observed that in 2021, the value of construction permits reached $126.5 billion, a 25.6% increase from the previous year. This marked the highest annual growth rate ever recorded.
"During the pandemic, people invested in their residences as they sought more space or comfort while working from home," he says. Investments were made in pools and converting basements into livable spaces.
At the same time, 2022 was the third most expensive year in recent Canadian history in terms of insured losses, at $3.1 billion. McCutcheon highlights the damages caused by the May 2022 derecho, totaling $1 billion in Ontario and Quebec, and Hurricane Fiona that hit Eastern Canada in September, resulting in insured damages of over $800 million.
"These are significant figures with an impact on our industry, and all of this in a very short period," adds McCutcheon.
Furthermore, reinsurance costs have significantly increased during treaty renewals in January 2023. "Our largest client was able to cover up to a limit of $50 million from their own capacity. Now, they need to increase their limit to $110 million before they can use their reinsurance contract," he says. This caused the insurer's expense ratio to rise by 2%, solely due to reinsurance. "Reinsurers precisely point to the poor evaluation of reconstruction costs as one of the main factors explaining this rate adjustment," he continues.
Above Average Impact
Greg McCutcheon believes insurers need to revisit their pricing to better account for inflation. He notes that a properly insured customer should not have to face a systematic increase in their limit every year. In his opinion, imposing this average 4.5% increase on everyone is equivalent to having well-insured clients pay for the inadequately covered ones.
Additionally, this 4.5% indexing is no longer sufficient to cover inflation. "When paying claims for total losses, we realize that properties are significantly underinsured," he says.
In the graph below, Opta assessed the evolution of reconstruction costs for the residential sector over three and five years. Across Canada, these costs increased by 19.4% over three years and 32.3% over five years.
In Ontario, Quebec, British Columbia, and Alberta, where the largest urban areas are located, the increase in costs has been above the Canadian average over the past five years. For the last three years, only in Ontario has the cost increase been slightly below the national average.
Opta regularly validates the reconstruction costs of major home insurers' portfolios. While a minority of buildings are properly insured, the firm consistently finds properties with insurable values underestimated by 100%.
In the commercial real estate sector, Opta also notes that the three urban areas where construction costs have increased the fastest in recent years are Toronto, Ottawa, and Montreal.
"There's no indication that this trend will decrease," insists Greg McCutcheon. The shortage of skilled labour in commercial or institutional real estate, along with the costs of materials and transportation, further fuels inflation in this market.
The Case of the Maritime Provinces
Regarding the rise in construction costs following losses caused by Hurricane Fiona in September 2022, Greg McCutcheon points out the unique situation prevailing in the Maritime Provinces. "You can have a house with a property value of $85,000 but insured for $250,000 in case of a total loss, as that's what it would cost to rebuild. That's not a good thing," he says.
During a recent visit to the Maritimes, it was reported to Greg McCutcheon that many claims filed after Fiona's passage were still open. Many property owners discovered that the compensation offered by the insurer fell far short of covering the reconstruction cost.
The Climate
As seen in Canada in 2023, climate-related losses from floods or wildfires are increasing in frequency and intensity. The country's temperature is warming faster, particularly in the northern part. The impacts of warming can no longer be denied, according to Greg McCutcheon.
"Historically, insurers saw Canada as a place where climate disasters were rare compared to the United States, where hurricanes and tornadoes occur more often," he recalls. This is no longer the case.
As a result, Lloyd's of London Underwriters have started to withdraw from certain commercial insurance markets in recent years. This insurer caution is not good news for segments already lacking competition, says Greg McCutcheon.
This trend is evident with insurers leaving states like California or Florida due to natural disasters.
Similar to the United States
In a recent blog published by Burns & Wilcox, consulted experts highlight the inflation-driven domino effect on underinsuring residential properties in the United States.
"If policyholders don't have their properties reevaluated by experts who understand the cost of reconstruction or replacement, there's a good chance they will be significantly underinsured," says Heather Posner, Assistant Vice President of the firm.