Reinstatement cost assessments: the growing problem of underinsurance

The rising risk of underinsurance: are your buildings covered?

No one likes to think about things like water or fire damage, but inflation may mean the cost to reinstate a building or rebuild may no longer be sufficiently covered by insurance policies. 

Henry Gallacher, Managing Director, Cape Insurance, says: “Research last year by building insurance valuation services company Barrett Corp and Harrington estimates 70-75% of all commercial property in the UK is currently underinsured.”

Reinstatement cost assessments to ensure appropriate insurance coverage are normally carried out every five years. But a string of economic shocks – BREXIT, COVID and supply chain disruption due to the war in Ukraine mean costs have risen sharply. 

“Prices have stabilised a little following fierce rise in 2021/22, but it can still be a challenge to pin down costs,” says Tom Lowe, Partner, Carter Jonas.

What are the RCA implications for building owners?

Insurance typically covers the costs of clearing, reconstructing using the same materials and professional fees. 

The problem is that if these reinstatement costs were assessed three, four or five years ago, there is a high risk the insurance won’t cover rebuild costs in today’s market. A clear example is the Royal Albion Hotel fire, which resulted in the demolition of part of the structure at a cost of £500k for Brighton’s council - “it shows that the costs for reinstatement is not always apparent and can quickly escalate” says Alan Doherty, Partner, Carter Jonas.  

Insurers will typically apply average clause, the percentage of a building that is underinsured. So, if the claim is for £1m, but the asset owner is 25% underinsured, the insurer will only pay out £750,000, leaving a £250,000 shortfall.

“But that’s probably not the worst of it,” says Gallacher. “When you get into territories of 35% and above underinsurance, especially 40-50%, we're starting to see the market looking to avoid claims in its entirety.” 

Insurers could invalidate the policy if it is felt the risk has been misrepresented at the underwriting stage, he says. 

Correctly assessed reinstatement costs will inevitably push premiums up at a time when premiums are already rising as the global insurance market is hit by more natural disasters. 

What are the steps owners should take to insure their buildings?

In the current market, Gallacher recommends getting a reinstatement costs assessment done if it hasn’t been done for a while and in the current market, doing them every two years. 

“Make sure the sum insured is index-linked year on year, so there is no wriggle room for the insurer to potentially say ‘you are underinsured’,” he says.

It’s also important that owners get a value based on the reinstatement cost, not market value; sometimes, the reinstatement can be an estimate and might not be accurate.

“The onus always falls on the client to make a fair presentation of the risk to the insurer, and that is where brokers come in,” says Gallacher. You might have bought a building for £3m, but the reinstatement cost might be significantly higher?

He estimates that 50-60% of property insurance at the moment is based on the market value rather than reinstatement cost.

Lowe says the discrepancy between reinstatement cost and market value can be large, particularly in a changing market. 

Georgian buildings used as offices in cities such as Bath are an example. He says: “The value of those assets has arguably gone down in the last two years; there is less demand, but they are expensive to rebuild because of the special features and appearance.”

Assessments may require an onsite visit for buildings that are different from the standard “vanilla build”, he says or older, listed buildings with decorative features such as cornices or fireplaces. 

“Scale floor plans are always really helpful, as is cost data if it's a new build project. Without that transparency, we default to the industry averages and norms,” adds Lowe.

Basing reinstatement costs on the preferential rates a developer negotiate might not be in the funder's best interests. Gallacher says funders don’t want to be left holding “a badly insured pile of ashes” if the developer goes insolvent and they don’t have access to the same prices for rebuilding. 

What are the mistakes to avoid when assessing reinstatement costs?

Lowe says it’s also important not to overlook the cost of replacing special technology and features. 

“We were assessing a portfolio of car showrooms, and normally we’d look at the building and fit out, workshop equipment etc, but in one instance, there was a high voltage charging unit, and the cost to replace that was £300,000,” he says.

Another consideration is changing building regulations. A 1970s industrial building won’t necessarily meet current regulations for things like energy efficiency but would have to be rebuilt to meet the new standards. 

The problem is that most insurance policies cover reinstatement, not “betterment”, so there are potential additional costs for the asset owner. 

“Some insurance policies, not many, include a greening clause to allow you to increase the energy performance up to current building regulations,” says Gallacher. 

Forewarned is forearmed when it comes to mitigating insurance risk. 

About Cape Insurance

Cape is an insurance agency providing expert risk and insurance advice to property investors, developers, owners and managers, finding solutions that help manage, mitigate or transfer risks, and optimise profitability.

 

 

 

Henry Gallacher,
Cape Insurance Managing Director
capeinsurance.co.uk/

 

CONTACT

For further information on RCA, please get in touch with our experts: 
Tom Lowe
Partner
T: 07879 430793
Tom.Lowe@carterjonas.co.uk 

Alan Doherty
Partner
T: 07765 745 103
Alan.Doherty@carterjonas.co.uk