The effects of inflation: uncertainty and atypical loss

This post is part of a series sponsored by CoreLogic.

Insurers affected by Hurricane Ian’s devastating path through Florida at the end of September 2022 faced operational, regulatory and legal demands for accurate projections of the final financial cost of the damage. They used to use disaster risk models to project their eventual losses, and the uncertainty limits of their loss estimates were much higher for that event. While hurricane loss models are able to estimate insured damage and losses to buildings and assets to a certain degree of certainty, other sources of loss are uncertain.

These uncertainty factors are referred to as post-loss amplification factors. This includes the factor of excess demand, that is, the short-term rise in prices driven by the extraordinary costs of importing overseas workers and materials, and cost inflation factors arising from regulatory aspects such as the Allocation of Benefits Act (AOB) in Florida. Post-loss inflation has plagued Florida’s insurance market for many years and has gradually worsened, culminating in a seemingly never-ending upward spiral of claims costs for Hurricane Irma in 2019.

Recent levels of historically high inflation fueled by material shortages and rising energy costs have contributed to significant increases in the cost of everyday goods and services, with consumer price inflation peaking at just under 10% earlier this year. Labor shortages also continue to be an issue, with the National Federation of Independent Business reporting that hiring is as difficult as ever.^[1]

Costs of building materials and labor used in rebuilding have risen faster than general inflation, with levels of just under 15% at the start of 2022. We can see in the chart below that these costs have seen an even steeper rise in Florida.

Figure 1: Change in reconstruction prices compared to the consumer price index.^[2]

CoreLogic’s loss estimates were calculated using the latest values ​​for rebuild costs. The problem is that insurance companies or agents may be looking at schedules or values ​​from twelve or more months ago that could be undervalued with little or no future inflation built into the schedule. Insurance companies’ costs are incurred once the repair is complete. As of November 22, 2022, approximately 50% of insurance claims were still open and 25% were still open as of January 20, 2023.^[3] More expensive claims take longer to fix with higher inflation leading to higher final costs. This delay is even longer for reinsurers.

In 2017, Florida made a significant building code change for existing buildings that required replacement of an entire roof section where 25% or more of the roof section was damaged and where there were permit, installation, or inspection errors.

Assignment of benefits is a well-established practice in Florida that enables a property owner to hire a contractor to repair their property and assign the benefits of their insurance policy to the contractor instead of paying outright. Designed to offer agility and speed to homeowners seeking to fix their property, the addition of attorney settlement fees to a claim increased costs for settlement insurance companies and, ultimately, increased costs for homeowners.^[4] In May of 2022, the Florida legislature implemented reforms to AOB laws and the effectiveness of these reforms has not been tested.

Revised 2017 regulations on AOBs such as reduced claims windows, cancellation rate and contingent fees will only have a significant impact on reducing costs if insurers can stop questionable actors from contacting their customers and start proactively handling early settled claims. More reforms enacted by an emergency legislative session have now banned (at least moving forward) the ability for policyholders to set their policy benefits to 3^{Research and development} Parties have restricted ability to recover legal fees. However, the legislation is not retroactive, so claims from Hurricane Ian are still subject to AOB inflation losses.

Hurricane Ian and Housing: By the Numbers

CoreLogic estimates that approximately 900,000 homes were exposed to hurricane-force winds, and 600,000 of them were exposed to severe Cat 2 or Cat 3 wind speeds. According to the Florida Bureau of Insurance Regulation, there were approximately 475,000 residential claims on record as of January 20, 2023, up from 440,000 claims on file as of November 2022.

The steady stabilization of these claim numbers may be evidence of the improvements made to the Building Code regulations for home strengthening in the years following Hurricane Andrew (1991). This high volume of claims will be a test not only of the adequacy of recent AOB reforms in reducing overall repair/insurance costs for homeowners to repair/insure their homes but also a test for insurers and reinsurers in managing the uncertainty of determining the final cost of Hurricane Ian.

To learn more about the effects of Hurricane Ian 6 months after it made landfall, check out this CoreLogic webinar exploring damage survey findings in southwest Florida including a detailed breakdown of typical losses and what made this hurricane so unique.

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