In this first article of our new monthly series, Keegan & Pennykid delve into the problematic issue of underinsurance, splitting the topic in two.
This month, we unpick the factors associated with underinsurance in buildings cover. Next month, we’ll examine underinsurance in business interruption cover and the impact it can have on moving forward after a loss.
Each month from then on, we’ll be exploring talking points and trends in commercial and third sector insurance to help you evolve your own risk management, mitigation and transfer strategies.
In recent years, buildings underinsurance has become a thorny issue for many policyholders. But by the time you realise the problem – generally at the point of making a claim – it’s too late to avoid its costly consequences.
So, just what leads to you being underinsured, why could it be costly, and how can you avoid it?
Generally speaking, underinsurance happens if you calculate the amount of buildings cover you need using the wrong property value, or if you haven’t got an up-to-date valuation.
Most people have a pretty good idea of what their property is worth – what it might sell for – and this is called the market value. But when you buy buildings insurance, you need to use the reinstatement value – that’s how much it would cost to rebuild.
This figure includes demolition and site clearance costs, professional fees – i.e. architects and surveyors – and the cost of labour and materials.
If you’ve inadvertently insured on the basis of the property’s market value, this can often be higher than the reinstatement value and means you’re paying for too much cover. But even if you’ve insured on the reinstatement value, the significant fluctuation in labour and material costs over recent years means it’s likely the figure will be inaccurate, unless it’s right up to date.
As an example, figures from the Building Cost Information Service show that in August 2020, steel rebar was £365 per tonne. Less than two years later it had more than tripled to reach £1,200 per tonne. In the last few years many building materials have seen annual inflation rates go as high as 80% before falling as low as -20%.
These swings have a direct impact on the cost of completing repair and rebuild projects and mean it’s easy to end up underinsured.
Even if your insurer increases your sum insured each year – called index linking – the general figure applied is unlikely to be an accurate reflection of the specific inflation rate relating to your building. And if you’re underinsured, this can create real problems.
Application of Average
Being underinsured can leave you with a hefty bill to pay in the event of making a claim. Let’s say you bought buildings insurance with a limit of £1m but following a loss it’s discovered that rebuilding the property would actually cost £1.25m. Your insurance only covers 80% of this figure.
Insurers will apply this percentage to any claim made, even if the claim is for less than the £1m limit.
If your building is destroyed in a fire, the maximum you’ll receive is £1m. This means it’s unlikely you’ll be able to replace what was lost and will have to rebuild to a reduced size or specification to remain within budget. This is clearly far from ideal.
But if your building is partially damaged, the outcome could be even worse. You’ll have to complete repairs to the existing building and there’s unlikely to be the same scope to reduce either the size or the specification of the repairs, as they’ve got to tie in with the fabric of the original property.
In this scenario, a flood may cause damage of £300,000. The insurer will apply the average of 80% and only pay £240,000, leaving you to find the remaining £60,000.
Insurers tend to show little leniency in cases of underinsurance and they’ll generally apply average at whatever level it’s discovered. This is why having an accurate sum insured is so important.
Valuations
There are two ways to make sure you avoid this scenario. The first is to have a professional and up to date valuation. This will ensure you’ve got an accurate reinstatement figure on which to base your insurance.
This is especially important if you’re carrying out significant renovations or improvements to your building that will have a material impact on its value. Including the cost of a professional valuation in the project budget will only account for a small percentage of the overall total and will give you an accurate figure on which to base your insurance going forward.
The second way is to use the checking service that some insurers provide as part of their risk visits, which provides an opinion on whether your level of cover matches your risk exposure.
If an insurer accepts that the level of cover in place is appropriate, they won’t then apply average if underinsurance is discovered when you make a claim.
It’s important to remember that an insurer’s checking service isn’t the same as a professional valuation. Also, if you move to a different insurer at renewal, they won’t accept the previous insurer’s view that the cover in place was appropriate in the event of an underinsured claim. In this scenario, the new insurer would still apply average, potentially leaving you with an expensive headache.
Act now
It’s easy to think that reviewing your sum insured is something that can be left until you renew your policy. But it takes time to arrange a professional valuation. We can help with this and provide access to a RICS-approved valuation service with costs starting from £180.
You should also review how the fabric of your building has changed over recent years and whether it’s undergone any significant building works. If so, updating your reinstatement valuation is even more crucial.
It’s also true that underinsurance in your buildings cover might only be part of the story. If a loss affects your building and impacts your ability to carry on your normal business activities, there’ll also be a business interruption loss to quantify and settle.
In many instances, this loss can be more damaging than the property loss. Making sure you’ve got the appropriate sum insured in place can be difficult and involves a number of fluctuating metrics.
We’ll be looking at this second aspect of potential underinsurance in next month’s blog. But for now, please check the basis on which your buildings cover has been calculated and get in touch with us at Keegan & Pennykid on 0131 225 6005 if you have any concerns.
Remember we have a particular focus on serving the third sector and a no-obligation conversation is sure to be time well spent.
