How does underinsurance happen?
There are several ways underinsurance can happen to policyholders.
Referring to some online calculators or simply making your best guess at a building’s valuation means that you may be insuring the property for less than its actual worth. Using an online calculator is not necessarily a bad thing if you are using a tool such as the ABI Public Rebuild Calculator.
The Association of British Insurers (ABI) has commissioned BCIS to provide general guidance to help you check the adequacy of your sum insured. The Building Cost Information Service (BCIS) of the Royal Institution of Chartered Surveyors (RICS) produces a range of detailed guidance on the cost of rebuilding houses and flats.
ABI Public Rebuild Calculator.
Many customers are unaware of how the insurance principle of ‘average’ works and how it affects the value of a future claim. Any shortfall in a buildings sum insured will be reflected in a proportionate shortfall in a claims settlement in the event of an insurable loss. For example, if the building should be covered for £1,000,000 but is only insured for £500,000, then the amount payable will be reduced by 50% because the building is underinsured by 50%.
Most policies have an index-linking clause which helps policyholders keep up with inflation, by automatically increasing your sum insured annually in line with various indices. This should ensure that your sums insured are maintained at a level where 'average' should not apply. The average clause is typically found in commercial property insurance clauses.
This pre-supposes however that the base values are correct in the first place. The consequence of under insured values would be compounded if the sum insured is set too low at the outset. Also, your rebuilding costs should be reviewed annually to take into account improvements or extensions made to the property.
It is a misconception that the sum insured is the same as market value - there is no correlation between the two. Neither should it simply be based on new build developers' costs.
Your building sum insured should also allow for the costs of demolition, debris removal, site clearance as well as the architects', surveyors' and other professionals' fees. Also don't forget to factor in costs for gates, fences or car parking areas into your calculations.
What factors affect rebuilding cost and can cause underinsurance?
It is very difficult to accurately calculate the rebuilding costs of a property as a variety of factors need to be considered:
- Size
- Location
- Type of property - unusual or specialist design?
- Construction and materials
- Age and if it is ‘listed’
- Your VAT status
What else should be considered when arranging buildings insurance?
- Loss of rent
- Alternative accommodation
- Business interruption
- Increased and additional costs of working
Property owners: If you are letting your property then you need to protect your potential loss of rent resulting from a significant loss or damage. Importantly you should consider the maximum period likely to rebuild the property. This could be anything from 12, 18, 24, 36 months or longer. Ask your adviser for guidance.
Businesses (manufacturers, wholesalers, warehouses, etc.): Similarly to the above guidance, you should consider the potential interruption caused to your business impacted by the length of the rebuilding period and subsequent recovery of your trading to the same levels as applied prior to the damage occurring. In the worst case scenario you may be unable to trade until the property is rebuilt.
During this period you may suffer a total or severe reduction in income and also may have lost customers. How will you pay your bills and continuing overheads? How long will it take you for your business to recover? You should discuss this recovery time with us, in order to determine the correct indemnity period suitable for you.
This is important as claims payments will cease once the indemnity period has been reached.