Index linking is a valuable protection against underinsurance, but it’s not completely foolproof. While it can help to reduce the shortfall if you’re unfortunate enough to require a total property rebuild, there are several scenarios in which your insurance payout will still be significantly lower than the rebuild costs.

In this guide, we explain what index linking is and why it’s not a silver bullet for underinsurance risk.

What does index linked mean?

Index linking is a process used to adjust a financial product (insurance policies, pensions, etc.) in line with inflation. When one of these products is “index linked”, the provider is using official economic measures (indexes) to calculate the required percentage increase to balance the product against inflation.

Index linking can be applied to a variety of different financial products, from investment gilts to savings accounts, but in the insurance world, its job is to automatically increase the sum payable so the coverage keeps pace with current realities. The premiums you pay for your policy are also adjusted proportionally to cover the increase in coverage.

An example of index linked insurance in action

Imagine you insure your home for £300,000 in 2024. This figure represents the total cost to completely rebuild your house at today’s prices for labour and materials.

If inflation rises by 5% over the following year, the cost of bricks, timber, and builder fees will likely increase by that same margin. Without index linking, your coverage would stay at £300,000, leaving you underinsured, meaning you’d have to pay the £15,000 shortfall out of your own pocket if your home were destroyed.

However, because your policy is index linked:

• The Coverage: Your insurer automatically adjusts your “sum insured” to £315,000 at your next renewal.
• The Premium: Your monthly or annual payment will also increase slightly to reflect the fact that the insurer is now taking on a higher level of risk.

It sounds great, and it can be. It’s certainly a fantastic idea on paper, but it doesn’t always provide the steadfast protection that unfortunately many assume it does.

Why index linked insurance isn’t full protection against underinsurance

Index linked insurance policies often fail to protect against underinsurance during a rebuild due to a mix of foundational data issues, lack of specific inflationary tracking, market lag, and unpredictable project scopes.

Initial sum insured was insufficient

Index linked home insurance, or indeed index linked property insurance of any kind, offers inflation-balancing adjustments in payout based on the initial sum insured. This may sound like ongoing revaluation, but technically it isn’t.

This means that if the rebuild cost of your property was incorrectly calculated as lower than it actually was at the time of assessment, that underinsurance carries forward even as your sum insured goes up. The funds added to the sum insured are to cover inflation only, not pre-existing underinsurance.

Generalised inflation monitoring

Even though providers monitor the most relevant indices to calculate adjustments for index linked policies, they might only be getting “big picture data” rather than specific details.

The indices used typically offer an average of building cost or retail price inflation for the average house. This means that any property that is different to the “average” house type will not be properly accounted for in index link insurance adjustments.

Houses with thatched roofs are an obvious example of an unorthodox structure, but the average problem can also impact more under-the-radar aspects of your property. Essentially, any element that was built with specialist materials or through specialist labour may not fully factor into the incremental increases in sum insured.

Let’s say, for instance, that you have a home featuring bespoke Italian marble flooring throughout the ground floor.

While your insurer applies an annual index increase based on general building costs (like the price of standard ceramic tiles or timber), the global market for luxury stone might be rising at a much faster rate. Furthermore, the specialist stonemasons required to install it are rarer than general floor fitters, and their labour rates may spike independently of national averages.

Because the index looks at “big picture” material costs:

• The index says: Your rebuilding cost has risen by 4% based on average materials.
• The reality: The cost to replace your specific marble and hire a specialist has risen by 12%.

Over several years, this generalised monitoring creates a significant gap between your insurance payout and the actual cost of replacing your premium finishes.

Regional discrepancies in rebuild costs

Property location has a significant impact on rebuild costs. Labour, materials, and logistics can all carry vastly different costs across regions, and these individual costs are constantly changing, making truly accurate tracking an impossibility for insurers.

So, if you live in an area where one or more of these costs are far higher than the average, your coverage isn’t going to keep pace, leaving you underinsured and potentially subject to “the Average Clause” should you need to rebuild your property.

RICS’ Building Cost Information Service (BCIS) is the index many insurance providers “link” policies to, yet RICS themselves warn that index linking for building sum insured “cannot exactly reflect changes in all rates from the house building cost tables as regional trends, labour and materials contents differ.”

As a solution, the BCIS “recommends that the rebuilding cost [of your property] is checked regularly”. Ideally, you should book a reinstatement cost assessment every 3 years. Find out why in our guide: How often should you have a reinstatement cost assessment?

Changes to building regulations

One of the major flaws with the index linking process is that it’s reactive, looking backwards at established average costs for buildings that have already been built to determine how much your coverage should rise.

As such, when a new building regulation comes into effect mandating new features for rebuilt structures or new developments, such as green upgrades or post-Grenfell safety appointments, these aren’t initially factored into the index link adjustments.

Index linked home insurance does factor in changes to building regulations eventually. But if you need to rebuild your property in the gap between a law coming into effect and the indices fully acknowledging that law, your payout will not cover the difference.

Unpredictability of the scope of work required to rebuild

There are certain aspects of a rebuild that are far less predictable than others. For example, the cost of site clearance depends entirely on the state of your property after it becomes damaged. It could be completely levelled, or there may be parts of the structure still standing. This means that indices can really only make a rough estimate of potential costs.

Ensure accurate buildings insurance with Cardinus

Index linking should never be relied upon exclusively. There are simply too many shortcomings in the adjustment approach that can leave you underinsured in your moment of need. As recommended by RICS and the BCIS, it’s essential to book regular reinstatement cost assessments, and you can do just that with Cardinus.

Our nationwide network of highly qualified assessors can carry out accurate reinstatement cost assessments for any property type, anywhere in the UK. Simply tell us a bit about your property, and we’ll handpick an assessor with extensive experience with the structure type, ensuring a confident and definitive rebuild valuation.

Fill out our short reinstatement cost assessment contact form to get started.