Case Study: The Importance of Accurate Rebuild Cost Assessment in Property Insurance
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Introduction
In property insurance, accurately assessing the rebuild cost is crucial. Failing to estimate this value correctly can result in underinsurance, leading to significant financial consequences in the event of a claim. This case study examines a property insurance claim involving underinsurance and highlights the importance of obtaining a professional valuation, understanding insurance terms like “average,” and ensuring declared values reflect true rebuild costs.
Background
A property was insured with a declared value significantly lower than the actual rebuild cost. This discrepancy led to the application of an “average” condition by the insurer, resulting in a reduced claim payout. Although the policy schedule included a sum insured value, which the insured believed would act as a buffer, insurers require that the rebuild value be accurate at renewal or policy inception.
The Concept of “Average” in Insurance
The “average” condition, also known as the condition of average, applies when a property is underinsured. If the declared value is less than the actual rebuild cost, any claim is reduced proportionally. For example, if a property is insured for 75% of its actual rebuild cost, only 75% of any claim will be paid.
Declared Value vs. Rebuild Cost
While the declared value and sum insured are often thought to be the same, they serve distinct purposes in property insurance. The declared value is the policyholder’s estimate of the rebuild cost at the policy’s inception, excluding future inflation adjustments. It represents the amount required to reinstate the property at the time of the policy’s start. It should include:
- The cost of reinstatement at current prices
- Compliance with public authority requirements (e.g., planning permission)
- Professional fees (e.g., architect fees)
- Debris removal costs, including site clearance
In contrast, the sum insured typically includes an additional allowance for inflation and other factors over the policy period, ensuring that there is enough coverage to account for changes in construction costs or regulations during that time. It acts as a buffer to prevent underinsurance, but the declared value must still accurately reflect the initial rebuild cost for the policy to be effective.
Insurers’ Approaches to Rebuild Cost and Underinsurance
AXA: Advises that if the property, at the time of damage, is valued at more than 115% of the declared value, the client is considered to be self-insured.
NIG: Average Free Wording
RSA: Will not pay more than the building sum insured shown in the schedule.
QBE: Applies average if the sum insured is less than 85% of the reinstatement cost.
Vasek: Limits payout to a proportion if the loss exceeds the sum insured.
Aviva: On a “Day One” basis, provides an 8% leeway; limits payout to 108% if declared value is under rebuild cost.
Zurich: Caps liability at the sum insured and requires the declared value to match rebuild cost at policy inception.
Allianz: Uses a “Fair Presentation of the Risk” clause for proportional reduction if the rebuild cost exceeds the declared value.
Folgate: Applies an average clause, reducing liability proportionately if declared value is under 115% of the reinstatement cost at policy start.
Case Analysis: The Property Claim
In this case, the property’s declared value was substantially lower than the actual rebuild cost, resulting in a proportionate claim reduction.
The insured believed they had close to the correct insured value, but insurers require that rebuild cost be accurate at renewal or inception. Additionally, a dispute over the square footage affected the sum insured calculation, showing that accurate measurement is essential.
Lessons Learned
Professional Valuation: Property owners should obtain a detailed rebuild cost assessment every 3-5 years to align insurance coverage with current market conditions. Our partner, REBUILDCOSTASSESSMENT.COM, offers a RICS desktop survey for only £175 (inclusive of VAT and fee).
Regular Reviews and Updates: Indexation helps adjust the declared value for inflation, but regular professional reviews account for construction cost changes and regulatory requirements.
Understanding Policy Terms: Policyholders must understand terms like “average” and how they affect claim payouts. Declaring a lower value to reduce premiums can lead to significant financial losses, and insurers may cancel policies and retain premiums if misrepresentation of risk is deemed “reckless.”
Conclusion
Accurate rebuild cost assessment is fundamental to property insurance. Underinsurance can lead to reduced claim payouts, leaving property owners with significant out-of-pocket expenses. Regular professional valuations and a clear understanding of insurance terms are essential for adequate coverage and financial protection.
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Insurer wordings accurate as of 15/10/2024
