Author: Paul Latham


Most ALARM members are likely to have a property exposure within their risk portfolio. If you are looking for insurance to provide adequate compensation following a property loss, it is becoming increasingly important to insure on the correct basis. It is an essential part of a risk management strategy for an organisation. Getting this wrong means your services are likely to be affected, and your reputation.

Claims payments

Underinsurance has become a significant concern for insurers over the last 18 months, with an increasing impact on claims payments submitted by public sector organisations.

The pandemic all but stopped property valuations. This, compounded with the significant and continuing rise in building costs, has meant rebuilding values that may have been correct three years ago, may no longer be correct for insurance purposes.

Where there is underinsurance, many policy wordings will allow underwriters to reduce claims payments in proportion to the amount of underinsurance. The relevant policy term is the application of the average clause.

Consider a building with a current sum insured of £7.2 million. A fire damages most, but not all of the property. Loss adjusters calculate the true rebuilding cost to be £9 million (underinsured by 20%). The cost of the loss is calculated to be £5 million. When applied, the average clause reduces the claim by 20%, meaning a shortfall of £1 million.

Some insurers will apply the average clause to individual properties, others will apply it to the entire portfolio. While the later would appear to be more reasonable for the public sector where some may have hundreds of properties insured, it does not absolve the insured organisation from their duty to declare accurate rebuilding values.

Reduced claims payment can be problematic and may result in:

  • Unbudgeted call on reserves.
  • Protracted and complex negotiations with insurers leading to extended build times and impact of service delivery.
  • Discontented stakeholders such as leaseholders and tenants
  • Reputation damage within the community.

How does a building become underinsured?

Underinsurance can become an issue due to:

  • Over-reliance on insurer’s index-linking.
  • Reliance on insurer valuations, which may be market accepted methodology.
  • Sums insured have used market value or the developer's costs.
  • Structural changes to the property have never been considered.
  • Fluctuating building costs have not been considered.

Any one of these can have a significant impact on a rebuilding cost calculation and can only truly be addressed by conducting a reinstatement cost assessment (RCA).

RCAs establish the likely cost of demolishing and rebuilding all property on site that falls within the definition of ‘buildings’ under the insurance policy.

The Royal Institution of Chartered Surveyors (RICS) recommends that an RCA is assessed every three years, or earlier should significant alterations be made to the property.

The options to perform a reinstatement cost assessment are:

  • Onsite assessment.
  • Onsite sampling exercise of typical properties within a portfolio.
  • Desktop assessment.
  • Combination of the above.

Onsite valuations are always preferred but due to economics this may not be possible.

Desktop solutions are cost effective where:

  • The footprint of the building is easily identified using digital mapping tools.
  • The property is not listed or not a complex construction.
  • Buildings that don’t have basements, cellars or underground car parks.

Listed buildings

It is inadvisable to rely on a desktop valuation to assess reinstatement values for listed buildings, due to their complex construction.

Scotland’s listing system is different, but the principles remain the same: employ a specialist valuer experienced in the property types being valued. This is the only way the reinstatement calculation can account for the sometimes artisan building techniques and materials used to comply with the requirement of the listing.

New properties

It is not appropriate to base your insurance rebuilding costs on the original construction costs.

Many factors can make reinstatement costs higher including:

  • Developers’ costs being set on fixed price tenders, in some cases years before completion.
  • Economies of scale for developers buying materials in bulk not usually replicated in claims situations.
  • Additional site access costs.
  • Demolition costs.
  • The need for works to commence urgently.
  • The addition of features and outbuildings post-development.
  • The need to protect undamaged sections of a building from the elements.
  • The need to protect adjacent buildings.

Should I include VAT in my valuation?

This is a contentious issue and there is often inconsistency in whether VAT is considered, and if so by how much.

As an example, the erection of a new single dwelling or residential block is zero rated for VAT (correct at July 2022). However, insurance claims are not always zero rated for total losses and therefore VAT is applicable to rebuilding costs in many cases.

VAT rates on buildings used for religious purpose and historic buildings is another inconsistency example.

In broad-based terms, when considering VAT in relation to calculating a rebuild valuation there are three main considerations:

  • What is the occupation or proposed occupation of the property?
  • What is the VAT status of the client or insured?
  • What is the insurer’s position relative to the application of VAT?

Consultation with a qualified VAT accountant to obtain the correct position for your circumstances is recommended. This should be conveyed to the valuer who can ensure the appropriate position is reflected in the RCA report.

It is essential to be aware of the risks involved in managing a 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 adequately help you protect your property.

Author Information


This note is not intended to give legal or financial advice, and, accordingly, it should not be relied upon for such. It should not be regarded as a comprehensive statement of the law and/or market practice in this area. In preparing this note we have relied on information sourced from third parties and we make no claims as to the completeness or accuracy of the information contained herein. You should not act upon information in this bulletin nor determine not to act, without first seeking specific legal and/ or specialist advice. Gallagher accepts no liability for any inaccuracy, omission or mistake in this note, nor will we be responsible for any loss which may be suffered as a result of any person relying on the information contained herein. No third party to whom this is passed can rely on it. Should you require advice about your specific insurance arrangements or specific claim circumstances, please get in touch with your usual contact at Gallagher.