The hardening attitudes of underwriters is seeing property pricing increase and claims being settled in strict accordance with policy wordings. This change has been driven by global factors and more local events such as the tragedy of Grenfell.
Policy holders may not realise that underinsurance may have a direct impact on the claims payments they may receive in the event of a property damage claim.
So, what impact can underinsurance have for you?
If a claim payment does not cover the full property repair/rebuild cost or reinstatement, it could mean funds may not be available to complete the rebuild. This may result in:
- Negative impact on service delivery to your communities
- Unavailability of vital meeting places for your communities and parishioners
- Complex and extended negotiations with insurers resulting in extended rebuild times
- Requirement to borrow on already stretched budgets
- Exposure to potential legal action for inadequate levels of cover from lenders and leaseholders
It’s an unfortunate fact that no party comes out of an underinsurance claim well: client, insurer nor broker. Apart from the financial repercussions of who has to meet any shortfall in claims monies paid by insurers there may also be reputational damage to your organisation.
How does a building become underinsured?
Underinsurance can become an issue as a result of several factors:
- Reinstatement Cost Assessment was completed many years ago and you have relied on insurer’s index linking ever since
- You have relied on an insurer’s valuation when changing insurers. Insurance valuation are generally not transportable between insures due to the methodologies used
- No professional valuation or Rebuild Cost Assessment has ever been undertaken
- Sums insured are based on a notional market value
- Incorrect estimation based on historical information
- No account has been made for structural changes which may have been made to the building
- No allowance for fluctuating costs of raw materials and labour. Availability of materials has a significant impact on their costs particular at the moment
- Developer’s costs are adopted instead of the true reinstatement cost
Underinsurance is an issue that is likely to always be around. Buildings are constantly changing value and there is always a risk that if you place insurance without examining how things have changed you may have an underinsurance risk.
Implications of underinsurance
The “Average Clause” is a standard policy condition in UK property insurance policies. In its simplest form the clause allows an insurers to reduce a claims payment by the amount of underinsurance present at the time of loss. By way of example:-
Consider a building with a current sum insured of £7,200,000.
A fire occurs which damages most, but not all of the property. Loss adjusters are appointed by insurers and they calculate the true rebuilding cost of the property to be £9,000,000 (in other words it was underinsured by 20%). The cost of the loss is calculated to be £5,000,000, but once the insurer applies the average clause – the claim payment is reduced by the amount of underinsurance (20%) leaving the policy holder £1,000,000 short of the full repair costs.
A regular Reinstatement Cost Assessment would have identified the underinsurance on which the policyholder could have acted.
What is the purpose of a Reinstatement Cost Assessment?
Sounds simple but it is there to establish the likely cost of demolishing and rebuilding all property on site that falls within the definition of Buildings as covered by the policy following damage by an insured peril.
Gallagher recommends that all clients conduct a cost assessment on a regular basis. This is underpinned by The Royal Institute of Chartered Surveyors (RICS) who recommends1 that a Reinstatement Cost Assessment is assessed every three years or earlier should significant alterations be made to the insured property with an annual adjustment to reflect inflationary effects
How do you perform a Reinstatement Cost Assessment?
There’s some different options as to how a Reinstatement Cost assessment can be calculated. The options include:-
- An on-site assessment and report
- An on-site sampling exercise of properties of similar type within a portfolio (if there are a number)
- A desktop assessment and report
- A combination of on-site and desktop assessments
Through a strategic partnership with Cardinus Risks Management (a leading health, safety and risk management specialist regulated by the RICS and vastly experienced in providing independent Reinstatement Cost Assessments) Gallagher is able to offer any or all of these option for our clients.
Whilst the preference is always to conduct an on-site assessment, in some cases it may not be necessary or financially possible to do so. Cardinus have, therefore developed a desktop solution, which can be used where :-
- the footprint of the building is easily identified using digital mapping tools
- non-listed
- buildings that don’t have basements/cellars or underground car parks
- non-complex elevations or unusual materials
What are Cardinus assessing within the Reinstatement Cost Assessment?
Normally Cardinus include:
- The main structure including foundations
- Half of the cost of party walls/protecting adjoining structures
- The peripheral features that form part of the development (on-site assessments)
- The cost of demolition of the above
- The cost of debris removal
- The cost of professional fees
Listed Buildings and the impact to reinstatement costs
Listed buildings present particular challenges when conducting a Reinstatement Cost Assessment and in most cases it is not possible or advisable to rely on a desk top valuation to assess your reinstatement values for insurance purposes.
A listed building in the United Kingdom is a building which has been placed on the Statutory List of Buildings of Special Architectural or Historic Interest. There are just under 500,000 buildings in the UK to which this applies.
- A listed building may not be demolished, extended or altered without special permission from the local planning authority (who typically consult the relevant central government agency, particularly for significant alterations to the more notable listed buildings). Exemption is provided for some churches in current use for worship, although in such cases the church organisation operates its own permissions procedure.
- For a building to be included on the list, it must be a man-made structure that survives in something at least approaching its original state. Most structures on the list are buildings, but other structures such as bridges, monuments, sculptures, war memorials, and even milestones and mileposts may also be listed. Ancient uninhabited or unmaintained structures, such as Stonehenge, are generally classified as Scheduled Ancient Monuments rather than Listed Buildings.
- All buildings built before 1700 which survive in anything like their original condition are listed, as are most of those built between 1700 and 1840. The criteria become tighter with time, so that post-1945 buildings have to be exceptionally important to be listed. A building has normally to be over 30 years old to be eligible for listing.
- In England and Wales, listed buildings are classified in three grades:
- Grade I buildings are of exceptional interest, sometimes considered to be internationally important. Just 2.5% of listed buildings are Grade I.
- Grade II* buildings are particularly important buildings of more than special interest. 5.5% of listed buildings are Grade II*.
- Grade II buildings are nationally important and of special interest. 92% of all listed buildings are in this class and it is the most likely grade of listing for a private residential building.
Scotland currently uses categories A, B and C rather than grades. The assessment criteria for the categories differs slightly from the English and Welsh system, so a category B building in Scotland is not necessarily equivalent to a grade II* building in England.
Some church buildings in England are still also classified as A, B or C rather than the current designation.
Due to the specialist nature of listed buildings Gallagher would recommend that you discuss with a qualified and experienced property valuer such as Cardinus, before considering RCA’s on listed buildings.
New Build or Newly Built Properties
A question that Cardinus get asked quite frequently is, “if I set my insurance cover based upon the original development cost of constructing the property, that should be adequate shouldn’t it?”
Unfortunately, in most cases development costs do not compare well, if at all, with the costs of reinstatement following e.g. a serious fire. There are many factors which make reinstatement costs higher including:
- The need to commence works urgently.
- The timescales involved when you have residents rendered homeless
- Demolition costs
- Changed surroundings due to the passage of time
- Addition of features and e.g. outbuildings post-development
- Additional site access costs
- The need to protect undamaged sections of a building from e.g. the elements
- Less efficient work programming requirements
- The scale of scaffolding and other access costs
- The need to protect and prop adjacent buildings
- The differing profile of professional fees
- Developer’s costs being set on fixed price tenders, in some cases longer than a year before the first plant is brought onto site
- Economies of scale for developers buying materials in bulk not usually replicated in claims situations
- Zero rating for VAT for new build (see VAT section)
Should I include VAT in my valuation?
This is a contentious issue and there is often inconsistency in whether VAT is taken into account and if so by how much.
As an example, the erection of a new single dwelling or residential block is zero-rated for VAT. However, insurance claims are not always zero-rated for total losses and therefore VAT is applicable to rebuilding costs in many cases.
There are many more inconsistencies examples being VAT rates for buildings used for religious purpose and historic buildings. It is not possible in a paper of this sort to comment on all, but in broad-based terms, when considering VAT when calculating a rebuild valuation there are three main considerations:
- What is the occupation/proposed occupation of the property?
- What is the VAT status of the client/insured?
- What is the insurer’s position relative to the application of VAT?
Gallagher would strongly recommend you consult a qualified VAT accountant to obtain the correct position for your circumstances. This should then be conveyed to your valuer who can ensure the appropriate position is reflected in their RCA report.
Conclusion
It is essential to be aware of the risks involved in managing your property portfolio, but it is also vital to seek professional guidance about the types of risk management and insurance strategies available and how they can protect your property insurance programme.
Ensuring you have the correct reinstatement values is an essential part of your risk management strategy. If you get this wrong, the services you provided to your Parishioners, residents and congregations may be affected.
Would you like to talk?
Please contact our Community team if you wish to find out more about the availability of the Gallagher valuation service.
The sole purpose of this article is to provide guidance on the issues covered. This article is not intended to give legal advice, and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and/or market practice in this area. We make no claims as to the completeness or accuracy of the information contained herein or in the links which were live at the date of publication. You should not act upon (or should refrain from acting upon) information in this publication without first seeking specific legal and/or specialist advice. Arthur J. Gallagher Insurance Brokers Limited accepts no liability for any inaccuracy, omission or mistake in this publication, nor will we be responsible for any loss which may be suffered as a result of any person relying on the information contained herein.
Arthur J. Gallagher Insurance Brokers Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: Spectrum Building, 7th Floor, 55 Blythswood Street, Glasgow, G2 7AT. Registered in Scotland. Company Number: SC108909.
