The impact of inflation on farm insurance
17 April 2023
With inflation seeping into every corner of our economy, the impact is being felt far and wide. But what is driving inflation and what does this mean for farmers and agribusinesses across Australia and New Zealand? Let’s take a deeper look at how farmers may be impacted and what they can do about it if they are.
Inflation and the supply chain
According to the Consumer Price Index (CPI), inflation in Australia is up 7.8% in the 12-month period leading up to the December 2022 quarter. Similarly, in New Zealand it is up 7.2% for the same period. So, what is causing these inflation hikes?
One of the main drivers of inflation is the rising costs felt in the construction sector. Costs for critical materials such as steel and timber have increased, though there are signs they are beginning to ease. Much of this is due to supply chain issues caused by the pandemic as well as labour shortages, but geopolitical risks, such as the war in Ukraine, are certainly impacting commodities as well.
Add these factors together and you’re left with supply chain problems that continue to hurt the pockets of farmers as they try to keep up with the rising costs of fuel, materials, equipment, fertilisers, crop seeds and so forth.
Inflation and underinsurance
How does all this talk of inflation impact a farmers insurance policy? Well, that comes down to the potential of underinsurance, which is when the sum insured is not enough to cover the rebuilding, repairing or replacement of the insured item.
In short, if you insured your farmhouse, shed or other related property for a certain amount a few years ago, the replacement value of that building may have increased so much due to inflation, that the amount you are insured for may no longer be enough to cover you in the event of a total or partial loss.
If you find yourself in a position of a total loss, you may have to fund the extra costs to replace the insured building or build something smaller. As well as how much money you could be out of pocket, farmers may need to factor in the time it takes to have trades attend the farm and complete the job itself.
Thanks to the supply chain issues we mentioned, construction may be delayed as the builder awaits materials or there could be a backlog of jobs that have been stalled due to labour shortages. Additionally, short term arrangements will need to be put in place to help with business continuity – and all of this will cost time and money.
Your level of risk depends on when your farm insurance policy came into effect and when it was renewed. For some, their policy may remain unchanged since the time an item was added to the policy or even the inception of the insurance policy itself. In which case, this would’ve been the last time the sums insured were altered – a common theme among farmers as they struggle to find the time or the head space to update their policies.
For others, the sum insured may have been reviewed and potentially updated at the policy holder’s most recent insurance renewal period. Regardless, it’s well worth looking into the sums in your farm insurance policy to make sure you’re fully covered. Also, check to see if your insurance policy includes indexation – and if it doesn’t, it could be worth adjusting your sums insured to reflect the true replacement costs and reinstating indexation if it’s a policy feature.
Indexation and your insurance policy
Indexation is an automatic increase to the amount of insurance cover you have, which ensures the value of your cover is not eaten up by the impacts of inflation. Usually, this is offered when it’s time to renew your coverage.
If indexation is already a feature of your policy, then your coverage may already be adjusted. However, not all sum insured values will index each year, and indexation may be limited to just the buildings insured on the policy, and sometimes only domestic buildings will index each year.
It is also possible to opt out of indexation altogether depending on the insurer, and some policy holders may have elected to do so or wind back the sums insured as a way of curbing the rising costs in their insurance premiums. But could that be doing more harm than good?
Over the past few years, indexation generally hasn’t kept up with the rising costs in construction. Policies have generally indexed 3% a year (this past year indexation has been higher, but still short of construction inflation) and hasn’t made up for the ground lost in prior years. Therefore, it’s possible that adding indexation onto your policy may not provide complete protection against inflation.
Farm motor and machinery
When we look towards the impacts of inflation on the agricultural machinery market, we are seeing the demand for new machinery and the second-hand market to be quite buoyant. This has been the case for some years due to supply chain issues, temporary full expensing encouraging vehicle and machinery purchases, and large parts of Australia returning to good seasonal conditions as they emerge from a period of drought. These, and other challenges, have pushed the prices in the second-hand market upwards and could well leave farmers short in the event of a total loss on their machinery.
Previously, it was common for the sum insured to be reduced on machinery items in line with the depreciated value of the item because policies are likely to settle a claim on damaged items for either the sum insured or the market value, whichever is less. But now, second-hand machinery items, including those that have suffered damages, are selling well at machinery dealers and auction houses. Therefore, the salvage value attributed to a damaged machinery item will be substantially higher than years gone by. It could even be higher than the sum insured value the insured has set for their machinery on their insurance policy.
Higher resale values of damaged machinery can also lead to the possible scenario of having what is a repairable item written off by the insurer as it is economically best to do so when considering the repair costs and the salvage value of the item when compared to the sum insured set on the policy. Much like with the domestic and farm buildings, farmers could be left short and needing to find significant funds that were not budgeted for to get replacement items back on farm to continue business as usual.
Protecting your farm and your livelihood
If you don’t want to feel the effects of underinsurance, there are a few steps you can take to help protect your agribusiness from rising inflation and the impact on your farm insurance policy.
Review your insurance policy and the sum insured values.
Work with your broker to ensure that the policy is fit for purpose and that the cover is adequate for your business needs.
Review the terms and conditions of the policy, paying close attention to any exclusions that form part of the policy.
Weigh the benefits of indexation against the cost of your insurance premium to decide if this is worth keeping or adding to your policy.
Ensure that you have planned and are comfortable with the risks you wish to transfer to the insurance market and that you have budgeted for the risks you wish to retain.
Consider engaging a valuer to assess the replacement costs of your buildings, vehicles, machinery and other infrastructure, and provide that information to your insurance broker.
Have a Business Continuity Plan (BCP) in place. Consider what would you do if you lost your shearing shed prior to shearing or where you would milk if you lost your milking shed. Ask yourself whether you are able to hire machinery or bring in agricultural contractors to complete the job. These are the types of scenarios worth thinking about before starting a BCP.
If you need help evaluating whether your farm insurance policy is fit for purpose or would like help with your risk management strategy, get in touch with a Findex insurance expert for a complimentary farm insurance health check.
See Disclaimer and Disclosure information.
Consumer Price Index Australia, ABS, January 2023
Consumer Price Index New Zealand, Stats NZ, January 2023
Producer Price Index Australia, ABS, January 2023
Annual construction cost growth hits a record high as industry slowdown looms, CoreLogic NZ, January 2023
Ship operating costs up 773%, Shipping Australia Limited, September 2021
How Soaring Shipping Costs Raise Prices Around the World, IMF, March 2022