As private individuals or as businesses involved in the property sector, our property is a significant asset and an asset that warrants protection via insurance. Similar considerations apply to commercial entities that own buildings from which their business operates. Every year there are hundreds of thousands of incidents of damage to buildings. Whilst this normally conjures up an image of fire, this is just one of the various perils that can cause serious damage to property and render it uninhabitable whether that be for residential occupation or for commercial purposes. Most perils that can cause damage to buildings are insurable against the cost of making good and indeed the consequential losses that can flow from a building being uninhabitable.
Not only are these risks insurable, but most insurance policies are written on what is called a reinstatement or new for old basis. Put simply, this normally means that the full cost of putting a building back to the condition it was in prior to the damage and the consequential losses are met in full. However, here comes the but……… this is reliant upon the Policyholder ensuring that buildings are covered for their full reinstatement value.
The Underinsurance problem
A significant part of the work we do at Cardinus on risk management surveys is in respect of valuation of buildings for insurance purposes, or Reinstatement Cost Assessments as they are commonly known and in any given year we undertake many thousands of these. Across this body of survey work over 50% of properties are found to be underinsured and a significant proportion are underinsured by 20% or more.
Underinsurance – the consequences
Most insurance policies include what is called an Average Clause or equivalent. Put simply, when underinsurance exists in the event of a claim this Clause means that, the amount payable under the policy is reduced in proportion to the underinsurance. Therefore, if a building is underinsured by 50%, only 50% of the cost of reinstatement will be received by the Policyholder. In the event of serious damage this can easily result in a large shortfall in the claims payment, a shortfall that then has to be found by the Policyholder. The reality is that if a building suffers fire damage that will cost £500,000 to reinstate, but the property is underinsured by 50%, only £250,000 will be payable, leaving a shortfall of £250,000 to be found by the Policyholder.
Similar considerations arise in protection against the consequential losses of a property being uninhabitable, in this context usually a loss of rent and/or cost of alternative accommodation. For a commercial enterprise the required protection would also be likely to include insurance against loss of profit.
Where a property is occupied in connection with a business, it may be possible to relocate to alternative premises on a temporary basis, or rely upon an indemnity under a business interruption policy. However, the survival of a business following a serious incident is best protected when buildings damage can be reinstated quickly, effectively and with full funding from a building insurance policy.
Where a property is solely or principally used for residential occupation that means that the occupants may have to find somewhere else to live unless or until the shortfall is resolved. It should be noted that alternative accommodation and loss of rent covers only operate for the reasonable period of reinstatement.
The good news is that avoiding underinsurance on buildings is easy and not costly to achieve. This is done by having in place a regime of Reinstatement Cost Assessment surveys. These are uncomplicated to arrange, they can often be undertaken without the need for internal access and viewed against the potential cost of underinsurance a Reinstatement Cost Assessment can be done for a modest price and indeed represents a good investment.
Various pricing models are available starting with a cost for an individual property, but with scope for economies of scale and savings when a portfolio of properties is involved.
Reinstatement Cost Assessments – the process
Once instructed to undertake a Reinstatement Cost Assessment we will arrange for one of our highly experienced surveyors to visit the property or properties, either by prior appointment or on an unaccompanied basis if this is appropriate. We will of course discuss these details with you in advance. The purpose of the site visit is to obtain full details of the nature, extent and construction of the buildings on site. All buildings will be measured using best practice per guidelines from the Royal Institute of Chartered Surveyors ready for the second phase, which is normally conducted on a desktop basis. Details of all additions and peripheral features on site will also be captured including the likes of outbuildings, boundary walls, car parking areas, etc.
Once back at the office the surveyor will ascertain the appropriate method of valuation, which is dependent upon the type of property and will then ascertain the correct rate or rates that should be applied to the measurements and the various elements of the property and peripheral features. We select rates using BCIS the de facto source for rebuilding costs data. The conclusion of this exercise will be to arrive at an overall assessment of the cost that would likely to be incurred in the event of the property requiring to be rebuilt following damage by an insured peril.
What should be included in a Reinstatement Cost Assessment
It is best to start by imagining the situation after a serious incident of fire damage. In the days following such a scenario it is necessary for the damaged buildings and the site generally to be made safe. When the buildings are extensively damaged and require complete rebuilding, firstly the remaining damaged buildings will need to be demolished and all debris removed from site. Whilst such demolition works will normally be subject to supervision by a surveyor, a range of professional fees is likely to be incurred in the subsequent rebuilding project, including planning and other statutory approval fees etc. Then there is the rebuilding work itself, which will of course be the major cost element. This includes the building envelope, sub-structure, roof, mechanical and electrical services, internal partitions, all fixtures and fittings, kitchens/bathrooms and structural and decorative finishes plus peripheral features.
In the case of business premises that are tenanted, the respective responsibilities of landlord and tenant will be defined by the Lease Agreement. These tend to be complicated documents and can impact upon the scope of buildings insurance required. Tenanted business premises will often incorporate tenant’s fixtures and fittings and Tenants Improvements, which will normally be the responsibility of the tenant to insure and not a matter for the buildings policy.
It should be borne in mind that the rebuilding of a damaged property is almost invariably at a higher cost than the original development and rarely bears any relationship to the market value of the property.
Historic Buildings and Listed properties, etc.
There are a whole range of additional considerations and thus costs that arise with the reinstatement of older buildings, those that are in Conservation Areas and buildings that have a Listing. Older buildings often require the deployment of specialist contractors and tradesmen whose skills and availability are in demand. Materials for such projects are often very expensive and not necessarily easy to source. When it comes to Listed properties the requirement from English Heritage is likely to be that the property is reinstated exactly as it was prior to damage and all under a tight regime of staged monitoring and approval. The consequences are that reinstatement costs are high and the reinstatement period will be longer than in the case of a modern building. It will be appreciated that the implications of underinsurance on these categories of buildings are something to be avoided.
Should allowance be made for VAT in Reinstatement Cost Assessments
This is a complex area and there are a number of considerations. Whilst the complete rebuilding of a property that is exclusively for residential occupation does not attract VAT on the costs, other than in respect of professional fees, repairs to the same building would be subject to VAT. Reinstatement of the majority of buildings that are in non-residential occupation would incur VAT on the costs. There is then the consideration of the VAT status of the Policyholder and thus ability to recover VAT incurred. This may be a simple issue, but can also be complicated where there are multiple interests and thus parties to the insurance e.g. freeholders and leaseholders with differing VAT status.
In order to avoid the pitfalls of underinsurance, the majority of our clients opt to have VAT included in the Reinstatement Cost Assessment.
Advice from an insurance professional should always be obtained.
How frequently should a Reinstatement Cost Assessment be undertaken
For most types of building we recommend that a full assessment involving a site visit should take place every 3 years, with a minimum of a desktop review annually. Whilst most insurance policies will be subject to index linking to try and ensure that the sum insured tracks the economic landscape, the construction industry is a dynamic one and is subject to influences and factors in respect of both labour and materials, which will not necessarily be fully addressed by index linking.
Asset protection via insurance is nothing other than prudent, ensuring that buildings are insured to the correct value makes sense. Where there are multiple parties and interests, it is also worth bearing in mind the potential for the party that has responsibility for organising insurance cover to be liable to the other parties / interests in the event of underinsurance.
Cardinus provides comprehensive solutions for freeholder and landlord responsibilities, managing agents and insurers, residential management companies, commercial tenants and anyone else with a legal responsibility for property. You can find out more about Cardinus’ buildings insurance valuations by visiting the product section above.