At a glance
- Incorrectly insured assets can cause major underinsurance problems down the line
- Qualified professionals are needed to establish the accurate insured value of a building
- Zurich urges its customers to make sure that building sums insured remain at the correct levels
A failure to establish the accurate insured value of some buildings is potentially creating a ticking time bomb for commercial property owners.
“Getting an up-to-date accurate assessment of reinstatement costs for insurance purposes must be an absolutely essential component for securing the future of a business,” said Gary Strong, a Director at the Royal Institution of Chartered Surveyors (RICS).
Avoiding the dreaded ‘clause of average’
What if an insurer questions the adequacy of your sum insured in the event of a loss?
If your building surveyor cannot support their rate with detailed calculations, the insurer may apply the ‘clause of average’.
Clause of average is a policy condition that requires the amount of a claim payment to be reduced proportionately if you have not insured your property for the full value or replacement cost.
For example – if you insure a building for £1,000,000 and the insurer insists that the true rebuild value is £2,000,000, the extent of the insurers liability is limited to 50% of an insurable loss. A fire causing £100,000 of damage will result in a maximum payment of just £50,000 leaving you to fund the shortfall.
Significant time can also be lost while this issue is debated and additional financial costs may be incurred such as independent assessments and legal fees.
“We recommend that anybody looking to do so commissions an appropriately qualified professional, such as a RICS building surveyor or quantity surveyor, with the relevant skills and discusses their options with their insurance provider.”
At present, a lot of property owners rely on commercial building insurance valuations that are often produced by a chartered surveyor, loss adjuster or insurance surveyor who derive a figure by applying a £ per square metre rate to the gross internal or external floor area of a property.
The valuer has historically used the latest £ per square metre rates for an average type of commercial property as provided in published cost data books and online data tools such as by the Building Cost Information Service (BCIS), which is part of RICS.
This, though, has sometimes led to cases of underinsurance, as well as over-insurance.
“The use of £ per square metre rates to assess the reinstatement cost of a property for insurance purposes has been common practice amongst surveyors historically and indeed will still be common practice amongst many surveyors today,” said Sean Durden, a Senior Consultant at Gleeds-Durden Restatement Valuations.
“The rebuild ranges indicated in published and online rating guides can be quite wide for some building types, by as much as £500-£2,500.”
Durden added: “Further review of more detailed cost analysis, which can be found in the BCIS Elemental Analysis section, may not be taken, despite the latest RICS guidelines now finally pointing surveyors in this direction.”
It is an issue that can obviously go undetected for many years and if a building is insured for less than its full reinstatement cost, in the event of extensive damage an insurer would only pay out a percentage of the cost of repairs because of the clause of average.
“It is quite a widespread problem, especially for properties fairly difficult to value such as listed properties, specialist designs or buildings with a high-specification finish – which is where the errors are most likely to come in,” said Jonathan Scotcher, Underwriting Manager for Real Estate at Zurich.
There are a number of different ways and methodologies used to come up with a building valuation. Assessments usually depend on the real estate portfolio and the knowledge of brokers, who will flag up any inconsistencies.
One such method of valuation is by using a quantity surveyor, such as Gleeds, who are experts in the financial management of building projects by using detailed calculations of the elemental costs involved, and can advise clients on realistic rebuilding budgets.
“We have seen differences of £10 million over-insurance and £15m underinsurance for a couple of listed properties which had been converted for residential and commercial use respectively – this is despite previous assessments,” said Durden at Gleeds-Durden.
“A recent example of underinsurance also came to light of a city centre shopping development which was underinsured by 43%, equating to £20m. Cases of £500,000 to £3m underinsurance are common occurrences.”
Ticking time bomb
Index linking, which is widely used by insurers to update the sum insured of a building from one year to the next as the policy is renewed, has run at around 1%-3% in the last few years.
However, solely relying on this over a longer period to maintain an accurate sum insured of a building may eventually lead to errors even if the rebuild figure has been correctly calculated in the first instance. The indexation applied may not accurately reflect changing regional trends and differing labour and material costs for a particular property.
This is why Zurich urges, every three years, for all of its customers to make sure that building sums insured remain at the correct levels.
“We are looking to support people who are taking a sensible and reasonable approach to ensuring that their values are adequate,” said Jonathan Scotcher, Underwriting Manager for Real Estate at Zurich.
Getting an up-to-date accurate assessment of reinstatement costs for insurance purposes must be an absolutely essential component for securing the future of a business
Gary Strong, a Director at the Royal Institution of Chartered Surveyors
“And in order to support this, we waive average for properties within such a programme provided that building sums insured are adjusted appropriately in three-yearly periods.”
However, due to cutting costs not all real estate portfolios have had their reinstatement values updated for insurance purposes on a regular basis since the financial crisis took hold.
“This means, in some instances, it is coming up to six or seven years now since some property managers/owners have had a review of their reinstatement cost assessments, which can leave the owner/manager personally exposed,” said Durden.
Other potential pitfalls for property owners trying to ascertain a correct building valuation include costs associated with the change in building regulations that have added significantly to the cost of a rebuild in recent years, the use of developer costs – especially recent developments, which could have been built at a significant discount – and using the market value of a property to establish a building sum insured.
“Using the market value can result in significant levels of underinsurance depending on geographic location,” said Durden. “This will impact on the vast majority of properties outside of London and parts of the southeast.”
In the event of a total loss, the professional cost assessment must allow for the cost of reinstating the specified premises to the existing design, to a standard equal to, but no greater or better than the existing condition, in accordance with current building regulations and other statutory requirements as may be applicable.
So, like many commercial insurance contracts, the devil really is in the detail and making sure assets are insured correctly – and not by educated guesses – could save a fortune in the long run.
For more information please see our interactive infographic on calculating reinstatement values, or speak with your local Zurich contact.