Is your building insurance keeping pace with escalating construction costs?

Most property owners understand that the insured value of their property should reflect its realistic total replacement cost. However, the implications of the surging building costs are substantial, as construction expenses now far exceed what many property owners initially estimated as their insured value.

Misconceptions about property valuations

A common misconception is that a property’s market and insurance values are interchangeable. In reality, an insurance valuation pertains to the cost of completely rebuilding a property, encompassing various expenses not covered by a market appraisal. These include material and labour costs, site access expenses, removal of debris and the reconstruction value of surrounding elements such as parking lots, auxiliary structures such as external paving, lighting, awnings, flagpoles, masts and antennae, satellite dishes, above and below ground tanks, signage, fire services, water and reticulation throughout site, walls, fences, and gates.

Valuations should encompass more than just buildings. Consideration should be given to machinery, equipment, and inventory, as inflation affects all of a business’s critical assets.

The liability cap encompasses expenses related to the building and its site enhancements, covering the asset’s direct replacement or reinstatement costs. This includes allowances for preliminary work and unforeseen contingencies. Additionally, it accounts for the expenses associated with demolition and debris removal, professional and statutory fees, any cost escalations within the policy period, and those incurred during the lead-time for demolition, building plan preparation, and council approval (assuming the loss occurs on the last day of the policy period). It also considers cost increases during the reconstruction period under the same assumption.

The consequences of underinsurance

Underinsurance can have severe financial ramifications, leading to potentially disastrous outcomes in the event of a claim.

The insurer may apply the ‘Average Clause,’ limiting the total payout based on the proportion of the underinsured value. In an inflationary environment, the financial consequences of the Average Clause can far exceed any initial cost savings a company hoped to achieve by insuring for a lower amount than the total rebuilding cost.

It is essential to understand that your policies may contain an Average/Co-Insurance clause, which dictates that you must insure for the total insurable value or within 80% of the replacement value of the insured property. If you are underinsured, your claim may be reduced in proportion to the amount of the underinsurance. In an inflationary environment, the financial consequences of the Average Clause can far exceed any initial cost savings a company hopes to achieve by insuring for a lower amount than the total rebuilding cost.

For instance, if you own a commercial property with a total estimated value of $200,000 and the property is underinsured to 80% of the property’s total value (amounting to $160,000), the sum insured under the policy is $144,000.

In the event of a loss of $100,000, such as property damage or unforeseen incidents, the insurer would pay out a proportionate amount based on the coverage percentage. In this case, the payout would be $90,000.

This case study highlights the importance of accurately assessing and adequately insuring your property to ensure adequate protection against unforeseen events and financial losses.

How to avoid underinsurance

To prevent shortfalls in insured values, business owners should stay informed about rising values by regularly reviewing their building insurance coverage.

Utilising a risk assessor and obtaining a professional building insurance valuation for commercial property assets can help maintain accurate insured values and avoid underinsurance. We recommend conducting these reviews annually to ensure the accuracy of reconstruction costs and insured sums.

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