AVOIDING UNDERINSURANCE - THE IMPORTANCE OF GETTING YOUR BUILDINGS SUM INSURED RIGHT
Underinsurance in relation to Property Insurance has always been a problem, but it is now thought that 94% of buildings in the UK are insured for the wrong amount, 80% are underinsured and 14% are overinsured. [1]
Unfortunately, there is no real policing of the adequacy of the “sums insured” for property insurance in the UK. The onus to set the rebuild cost for insurance purposes rests with the policyholder, who understandably does not always have the relevant experience or qualifications to calculate the appropriate level to set the insurance cover at.
Underinsurance usually only comes to light when a claim is made, at which point it’s too late, leaving the policyholder significantly out of pocket and facing the harsh financial consequences of having to fund repairs or rebuild works themselves.
Common mistakes made by policyholders include basing the sums insured on the market value of the property, using the sums insured adopted from a previous owners insurance policy, or by “guestimating” the sums insured based on limited knowledge of what it might cost to rebuild a property.
This situation is far from ideal but reflects the general attitude towards rebuilding costs which if left unchecked can have a huge financial impact on policyholders.
For professionally managed properties, this risk is somewhat reduced as a good property manager or managing agent should have processes in place to mitigate the risk of underinsurance, but many of the points raised here are still valid.
In this article, we will cover;
- What underinsurance is and explain the concept of average
- Explore why you might be underinsured and
- Map out how you can avoid being underinsured
Underinsurance & Average
If a policyholder is underinsured, they are effectively taking on a percentage of the risk themselves. In the event of a claim will have to find the funds to cover the shortfall themselves, as most insurances policies are subject to an "average" clause. Here’s how it works;
If you insure your property for £500,000 but the actual cost to rebuild it is £1,000,000, there is a £500,000 shortfall, you’ve only insured 50% of the rebuild cost of the property. Most people would understand that in a total loss situation the maximum insurers could pay out here would be £500,000.
Insurers will view the above situation as them having only received 50% of the premium that they should have received for the property at risk and so they will only pay out 50% of any claim. Importantly though, and a point which is often misunderstood, this also applies to partial losses because the sum insured is a rebuild value rather than a policy limit.
For example, using the scenario above (of a property being 50% under-insured), if you have a loss of £20,000 and a £250 excess, the insurer will adjust the claim by 50% to £10,000 less the excess, paying £9,750 in total. It is worth noting that the excess is deducted after the adjustment for average is made.
This example highlights the possible financial impact of not insuring at the sufficient level, but there are other risks. With the introduction of the Insurance Act 2015 policyholders are duty-bound to disclose a material fact about the risk which they know or should know. If an insurer thinks that the policyholder’s underinsurance was reckless or deliberate, they may seek to avoid the policy entirely, making no payment and leaving you uninsured for the full amount of the loss.
There are also some less obvious indirect risks of under insurance. In the case of Residential Committees or Residential Management Companies, under insurance can create a personal liability risk for Directors who can be held personally accountable for their acts/omissions, or for Property Managers and Managing Agents, underinsurance can create a Professional Indemnity exposure, if disgruntled clients look for someone to blame after not receiving a full pay out for their buildings insurance claim.
Why you might be underinsured?
There are a number of reasons why you might find yourself under insured and we’ve covered a few of these below:
VAT
With VAT currently at 20%, the inclusion or exclusion of VAT can have a significant impact on the adequacy of the property’s sums insured. Sadly there isn’t a simple answer on this topic and it remains a contentious issue. However we have outlined some of the complexities and challenges of VAT as applied to rebuild values below:
If you are VAT registered then you do not need to include VAT in your buildings sums. Insurers would deduct the VAT element from any claim payments on the basis that you can recover the VAT element of any rebuild/repair costs from HMRC.
Going by the same logic, if you are not VAT registered, you would not be able to recover the VAT element of repair or rebuild costs from HMRC and so would rely on your insurers to cover both the repair or rebuild cost plus the VAT element. You should therefore include VAT in your building sums insured, essentially adding 20% to your sums insured.
However as alluded to above there are additional factors to consider when thinking about whether to include VAT or not in your building sums insured. For example, the rebuilding of residential property is zero rated for tax purposes, so if a residential property has to be completely rebuilt, no VAT would apply to the rebuilding costs. That sounds quite straightforward, however most insurance claims are for partial losses, and so making good these repairs would incur VAT! Another consideration is that costs such as debris removal and demolition costs (costs which you would incur in the event of an insured loss) do incur VAT.
Our own view and recommendation is to include VAT within your buildings sums insured. This does mean that the premium charged will be more, but this removes any uncertainty around VAT in the event of claim. There is no penalty for being over insured (other than paying a slightly higher premium) but there certainly is a penalty for being under insured (in the form of Average).
For specific guidance for your own property sums insured and the VAT position, you would be advised to seek professional advice from chartered surveyors and tax advisors.
Inexperience and familiarity
If you are not familiar with construction costs or are inexperienced in dealing with insurances, it is quite easy to get the sums insured wrong.
For example, the definition of buildings within a typical insurance policy will include outbuildings, fences, driveways, walls, gates, car parks, roads, paths, underground pipes & cabling, and so the total rebuild value of the “building” is often under estimated.
Additionally rebuild values need to include a provision for site clearance/debris removal and professional fees and costs associated with rebuilding a property such as architects’ fees, surveyors’ fees and planning applications fees.
In some extreme examples sums insured are merely guessed at without appreciating the severe financial consequences of getting it wrong.
Inflation
Due to wider macro-economic factors and supply chain issues, we are experiencing dramatic increases in the costs of building materials and labour. It is reported that between July 2020 and July 2021, the cost of materials rose by 20%, according to the Office for National Statistics (ONS). This means that, unless there is provision within the policy to deal with this, a property can quite quickly become under insured.
Insurers often include “index linking” or a “day one uplift” provision, to help protect policyholders against under insurance however these are quite generalised increases and do not relate to the individual and specific features of each property.
Relying on your Insurance Broker
There is a common misconception that your insurance broker can help you set the sums insured. However it is important to note that insurance brokers are not qualified surveyors. We can provide advice around the most appropriate insurer or product for your property, but we are not qualified to provide advice around the adequacy of sums insured. For that you would require the services of a Chartered Surveyor.
What can you do to avoid underinsurance?
We couldn’t be more clear that the best method for ensuring that your property is insured for the correct value is to procure a Professional Valuation. For buildings insurance this is commonly known as a Reinstatement Cost Assessment or “RCA”. This would ideally be carried out by an RICS (Royal Institution of Chartered Surveyors) approved surveyor.
These Reinstatement Cost Assessments (RCAs) are usually completed following an on-site visit and provide the policyholder with comprehensive and detailed report breaking down the reinstatement cost into all of its components.
Not only should this give you an accurate assessment of the rebuild cost, but by going through a professional you will have added protection. In the event of a claim, if an insurer’s loss adjuster still raises a concern around under insurance, you can provide them with a copy of the report which shows that the sums insured have been carefully and professionally considered. If insurers still deem that there is an under insurance issue, you would have recourse via the surveyors professional indemnity insurers. Reinstatement cost assessments can also provide relevant risk information that your broker can use to place cover for the risk such as the method of construction.
We recommend that reinstatement cost assessments (RCA) are carried out regularly (e.g. every few years) to ensure that a property remains adequately insured. If you manage several properties or portfolios of properties as is often the case for professional property managers or managing agents, it is good practice to have in place a “rolling schedule” of valuations, so that all properties are reviewed regularly. Not only does this combat under insurance but it also means that you can negotiate a better price for the RCAs and spread the cost across the portfolio.
Spending money on professional valuations may be off-putting, but the cost of the report and arranging cover on the correct basis will be a fraction of the potential cost of being underinsured in the event of a claim.
Get in touch
Champion Insurance Group are experts in arranging insurance cover for properties and property portfolios for owners, residential management company, property managers and managing agents. With full market access you can be assured of competitive premiums and market leading cover. If you wish to discuss your property insurance placement requirements, please get in touch.
E info@champion-insurance.co.uk
T 03330 430 430
Sources [1] - https://www.rebuildcostassessment.com/single-post/which-properties-are-most-underinsured