In an exciting collaboration between Minet Malawi, Britam, and The Daily Times - Malawi's leading newspaper - we are thrilled to introduce a groundbreaking initiative that will redefine your Wednesdays. Welcome to the Insurance Insights Column – a weekly rendezvous with the world of insurance and contemporary issues that matter. Every article aims to illuminate the intricate landscape of insurance products and relevant topics that impact us all. The articles will be educative at all levels, catering to both practitioners and non-practitioners.
As published in The Daily Times (Malawi) on January 24th, 2024
Late last year – on 8 November to be precise – the country’s monetary authority, Reserve Bank of Malawi, devalued the local currency, Kwacha, against the US dollar by forty-four percent. Economic and political pundits have commented on the origin and effects of the devaluation. One thing that came out clearly from the discourse is that devaluation has far-fetched effects on the stability of macroeconomic fundamentals. Devaluation for an economy that is import-based, like Malawi, is inflationary. Inflation by its nature triggers an upward spiral in the prices of goods and services, which in turn affects people’s cost of living and the cost of doing business including insurance.
When an economy catches the flu through unstable macroeconomic functions - such as high inflation - the effects cascade down. The sub-sectors follow suit. It is therefore important for the sub-sectors, such as insurance, to develop anti-inflationary measures in order to cushion against subsequent negative knock-on effects.
Inflation is one of the most talked about socio-economic evils in the commercial world. It is an enemy of business people and politicians alike. Whenever it materializes, inflation causes serious problems for the insurance industry. Put it directly - inflation increases replacement and reinstatement costs of insured property. It is therefore required of the insured public to revise the sums insured of their property to be in line with the new replacement and reinstatement costs whenever the devaluation of a currency takes place. If a loss occurs and it happens that the insured party did not carry adequate insurance for their insured property, they get penalized. Insurers apply what they call ‘average’ in calculating compensation. The application of average penalizes underinsurance. The claimant becomes its own insurer for the underinsured portion of the insured property.
To address this problem, insurers have developed several mechanisms that are incorporated into policies to act as ‘coolants’ to stabilize the effects of inflation at the reinstatement stage of the damaged insured property. These stabilizers are reminiscent of the safety valves of a life jacket.
The most commonly used inflation stabilizer is the escalator. An escalator provision allows the sums insured to grow on a daily basis so that whenever damage to insured property occurs, the sums insured are adequate. Insurers charge an additional premium for this option. It is usually 50 percent of the increase in the sum insured from the start to the end of the policy period. The choice of the multiplier depends on the ruling rate of inflation. It is a derivative of the maximum figure the inflation rate is expected to hit in a particular calendar year. Figures from the National Statistics Office released in December last year indicated that the country’s inflation had increased from 33.1 percent in November to 34.5 percent. With the rate of inflation hovering at 34.5%, an escalator value of at least 40% suffices. The escalator value is determined by the rate of inflation plus five percentage points.
The other inflation-proofing mechanism used by insurers is ‘day one’ insurance. This cover is recommended for high-valued properties such as multi-story buildings, factories, and machinery, therein. The insurer uses the reinstatement value of the property declared by the insured on the first day of cover as the sum insured – hence day one. The sum insured increases at an agreed percent over an insurance period. However, it is the insured’s obligation to make sure that the sum insured of property is adequate at the inception of the policy, otherwise, they get penalized by the application of average in case of a loss.
Comments
Post a Comment