Beware the consequences of underinsurance in the current economic climate, warns Standard Bank.
The recent slide in the value of the rand and the resultant volatile economic climate could have serious consequences for South African businesses that are unaware that the insured values of their imported assets may have dropped substantially below the present replacement or repair costs, warns Standard Bank.
Fluctuations in the rand
Cutting across the entire spectrum of South African business from electronics to machinery, equipment and even yellow metal to retail outlets, the recent significant loss in the value of the rand – touching a low of almost R16 to the dollar, a decrease of 15% since November 2015 – has seen the replacement costs for imported assets spiralling upwards; creating potentially costly pitfalls for those who are unprepared, says David Wedderburn, Regional Manager of Corporate and Business Insurance for Standard Bank Insurance Brokers.
Although fluctuations in the rand against key international currencies are nothing new, it is the magnitude of the latest change that is of concern.
”While the value of the rand has fluctuated in the last 20 years, these changes were not as severe as those most recently experienced. Clients have therefore until now been able to use the annual renewal cycle to compensate for any annual inflationary influences and changes in the value of the rand.
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“In addition, currency fluctuations were built into margins within the underlying insurance policy for clients who operated capital intensive businesses. This included clients who were importing high-value machinery and equipment for the construction and mining industries. It was also possible in the past to deal with the specialised needs of clients on an ‘as-needed’ basis or provide for their needs by modelling a slow decline in forex values.
“The most recent drop in the value of the rand, however, has been far more sweeping in its implications. It has impacted on virtually all sectors within our client portfoliosand we therefore have to look at the impact of this change on a sector by sector level.
“The major impact has been on imported goods. The costs of maintenance have also not escaped the slide in the rand as the cost of spares has rocketed.
Unexpected costs of equipment failure and replacement
“Some industries, such as those relying on the importation of consignment goods using the dollar as a base, have seen their cash flows hit. These traders have had to exercise caution with sales to clients because of the dramatic increase in their stock acquisition prices.”
At a micro level, says Wedderburn, even small to medium enterprises and shopkeepers in local malls have not been exempt from the insurance aspects of the rand’s slide.
“These days every business has computer equipment, office machinery or purpose-designed machinery. For smaller business the potential for unexpected costs related to equipment failure or replacement could be critical.”
Although the impact on business needing imported equipment will vary according to the currency in which the purchase was negotiated, the businesses most likely to feel the pain of adverse forex levels (primarily the US dollar, Euro or British pound to most South African enterprises) are those who bought their equipment a few years ago.
Equipment bought four years ago in Europe for import needing to be replaced could cost up to 30% more. Unfortunately, says Wedderburn, the older the equipment the more likely that maintenance and purchase of spares will be required – something that also has to be catered for with appropriate financial planning.
Related: Managing risk
Potential losses could be exacerbated if the insurer applies the ‘average’ principle to a claim, warns Wedderburn.
“If equipment is underinsured and the insurer applies ‘average’ to the level of underinsurance, this could result in a large financial loss being incurred in the event of a claim. To safeguard their own interests, companies seeking coverage should therefore ascertain how the ‘average’ clause can be removed from policies.
“If income is dependent on imported equipment, the business interruption values will also have to be considered. Financial losses attributed to damaged equipment, theft or other causes could be significant when compared to when the equipment was originally acquired.
"Finding profitability badly impacted on and then finding that the business is underinsured for business interruption would therefore be a double-blow. With the situation regarding the international value of the rand unlikely to change in the near future, the emphasis should be on protecting assets and ensuring that the possible risk resultant with damaged equipment is minimised. A valuation of assets and discussions with a professional adviser are advisable."