Are you under-insured? Inflation poses an existential risk to every property owner…

Buildings insurance usually covers loss or damage caused by: fire, explosion, storms, floods, earthquakes, theft, attempted theft and vandalism, frozen and burst pipes etc, and a good landlord’s policy will cover much more besides.

A crucial aspect of property insurance is the buildings cover and the replacement value recorded on the policy. Get this wrong and you could be faced with a big shortfall in the event of a claim – it’s the difference between the value on the policy and the actual cost of re-instatement, after say a major fire.

The rapid rise of price inflation and shortages, particularly affecting building materials, now has the potential to leave thousands of property owners under-insured and subject to what is a condition written into every policy and what insurers term “averaging”, should they have occasion to make a claim.

The Condition of Average

When you insure a building you declare to your insurer the ‘insured value’, which then forms the basis of the insurance contract, the sum insured under your policy on which the insurer calculates the premium due. The insurer charges you this Insurance Premium every year, based on the declared sum insured.

The insured value represents what it will cost to re-instate the building and is not the same value as the market price. This insured value should also take into account all the associated costs of re-building, such as site clearance, professionals’ fees, building control costs etc.

It is very easy for a property owner to get this sum wrong, as without a professional assessment most commercial and some residential buildings are very difficult to assess when it comes to defining a true replacement value. Most insurers will up the insured valued annually to keep it in-line with inflation, but if the value is not right to start with, this safeguard does not help.

And with building materials costs rising at a faster rate that CPI and RPI inflation indices, it is almost certain that the replacement cost will race away from your initial insured value.

The consequences of getting it wrong

So, if you get your insured value wrong it will likely be less than the true value at risk, the valued your insurers have calculated your premiums on – you would be paying year-in, year-out less that you should have paid to cover the true property risk.

In the event of a claim therefore your insurers would more than likely look at the cost of the claim and apply their Condition of Average. This is a basic insurance doctrine and a clause in your policy that says that if you have declared an insurance value of say £400,000 on your building, and the total loss claim comes to £500,000, then you were actually 20% under-insured.

In this situation the insurers would be within their rights to reduce your total loss claim by 20%, or indeed any claim for a smaller amount would also be reduced by 20%. In the above example the insurers might pay out accordingly, or £500,000 x 0.8 = £400,000. You would be £100,000 out of pocket.

What’s more, any excess on the policy is deducted after the claim has been averaged, so your real loss with be even more.

A hard lesson to learn

This would be a hard lesson to learn after the event. Insurance contracts are based on a powerful legal principle which means it is a contract of the “utmost good faith”. Honesty and openness shall always be observed between the parties. Anything stated in the insurance proposal by the insured, and any changes that might occur after the policy is taken out, and that includes the insured value, must be accurate and -0declared to the insurer without delay.

Nick Williams, a partner and commercial surveyor at Arnolds Keys says that:

This is a serious potential problem for property owners (under-insurance) and “is a direct result of rampant inflation in the construction sector: the latest BCIS Building Cost Index published in February suggests a year-on-year rise of more than 10pc, with construction materials inflation running at nearly double that figure. These are cost rises well in excess of the already hefty CPI inflation rate – and the result is that it is very easy to find your commercial premises under-insured.”

It is good practice for property owners to commission an insurance valuation periodically to keep the insured valued (replacement cost) in-line with rising prices, especially in the case of replacement building costs. Landlords and property owners generally would do well to check their policies regularly and review the reinstatement cost on an annual basis.

A good landlord policy will cover far more that just the rebuilding costs, so it is worth shopping around and comparing policies’ cover like for like.

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