Sam Forbes: Buildings underinsurance

10 Feb 2022 Expert insight

Sam Forbes discusses the issue of buildings under-insurance and how to avoid it.

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A recent report by Barrett Corp & Harrington Ltd (BCH), a Royal Institute of Chartered Surveyors (RICS) regulated buildings insurance valuation company, identified under-insurance in 74% of buildings appraised, with the average recommended increase to a building’s declared value being 81% during 2021 alone.

Increased labour and building material costs brought about by both the pandemic and Brexit during the past 12 months have further exacerbated the situation, making it now more important than ever for charities to review buildings sum insured to ensure they are adequate to reflect the total reinstatement cost of a property in the event of a total loss.

What is a buildings sum insured and why is it important?

A buildings sum insured is the basis on which an insurance premium is calculated and must consider all aspects of a rebuild following a loss, including architects fees, site clearance and remediation right through to the replacement of finishes and fittings, and external structures to return the building into a pre-loss position.

While over insuring a property means paying too much for buildings insurance cover, insuring a property for an amount that is not adequate to reinstate it in the event of a total loss could have severe consequences.

Should a buildings sum insured be found to be inadequate in the event of a claim for loss or damage, an insurer can reduce the value of the claims settlement proportionately in line with the amount of under-insurance – this is known as the application of average. For example, if the cost to rebuild your property is £1m but your buildings sum insured is only £500,000, then you would effectively be underinsured by £500k or 50%. In this example your insurer would only cover 50% of any loss, no matter the size of the claim.

What’s more, in a worst-case scenario, under the terms of the Insurance Act 2015, an insurer may consider that the declared sum insured represents a deliberate or reckless breach of a policyholder’s duty and may therefore be within their rights to decline the claim and void the policy with no return of premium.

It is therefore vital that a buildings sum insured is adequate to minimise the potential risk of under-insurance to a charity in the event of a claim.

Common causes of buildings under-insurance

In addition to the more recent impact of Brexit and the pandemic on reinstatement costs, in our experience, common causes of buildings under-insurance include:

  • The buildings sum insured has been mistakenly based on the market value of a property, or a mortgage valuation. For insurance purposes, the buildings sum insured needs to reflect the full cost of reinstating it following a total loss.
  • The buildings sum insured is based only on the cost to reinstate the main building structure and does not account for items such as foundations, boundary walls, outbuildings, drains, driveways, and car parks, which all fall within the definition of buildings under an insurance policy.
  • The buildings sum insured does not factor in the additional costs involved in reinstating the property including site clearance and demolition, as well as costly architects and surveyors’ fees involved in the reinstatement process.
  • Features specific to a building such as listed status or period features have not been factored into the reinstatement cost.
  • A property has been altered or extended but the sums insured have not been subsequently reviewed.
  • A building has never been professionally valued for insurance purposes or the valuation has not been reviewed in the past three years.
  • VAT has been omitted completely or applied incorrectly.

Case study

A domestic violence organisation completed a major refurbishment project on one of its main sites (site A) costing £360,000. The work involved the conversion of ground and upper floor into six self-contained flats.

Following completion of the refurbishment works, the policyholder was recommended to obtain a professional reinstatement valuation of the property. At the same time, they also asked for an additional site (site B) to be visited as it had been a number of years since the buildings sum insured had been reviewed at this location. The results are noted in figure 2.

In the case of the above, if we use an example of a large fire claim at site B, which resulted in repairs of £500,000, the amount that insurers would pay is 63.1% of the repair costs or £315,500. The policyholder would have to bear the shortfall of £184,500. For any charity this is a significant impact and one which could affect the long-term financial viability of the organisation.

As a result of the professional reinstatement cost assessment (RCA), the organisation increased its buildings sum insured in line with the recommendations to ensure that the sums insured were adequate going forward. This proactive approach gives organisations peace of mind that in the unfortunate event of a claim, their property is insured correctly.

How to avoid under-insurance

A buildings sum insured should be reviewed annually to ensure it adequately reflects any alterations, improvements or replacements that have occurred during the year as well as the factors listed above. It is not sufficient to rely purely on index linking that may be applied to some policies at renewal as a substitute for thorough annual reviews and regular professional valuations.

Additionally, if a professional valuation has never been undertaken or more than three years have elapsed since this was last reviewed, an RCA undertaken by a RICS qualified surveyor is the most reliable way to ensure a property is adequately insured to minimise the risk of under-insurance to a charity.

Sam Forbes is a development executive at PIB Insurance Brokers

Charity Finance wishes to thank PIB for its support with this article

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