Underinsurance: Is Your Sum Insured Up To Date?

Is your sum insured enough for a fresh start?

Imagine that the worst happened to your business: your premises burnt to the ground, were ravaged by an earthquake, or were otherwise severely damaged and in need of replacement. Most companies pay for insurance to safeguard their operations against this very scenario. Understandably, it would be pouring salt on the wound for them to find out that their policy does not nearly cover the cost of construction.

This is underinsurance: when an insured individual or business fails to update its policies to keep them in line with property and/or asset values.

The dangers of underinsurance

Properties are required to be insured up to an agreed amount so that the insurer can calculate an appropriate premium for the amount they would be required to pay in the event of a rebuild. It’s important that the sum insured reflects the actual cost of building a new facility. If it doesn’t, your or your business will be left with the rest of the bill in what will already undoubtedly be a very difficult time.

While insuring your property for less than the amount it would actually cost to rebuild may save a little in premiums, this false economy can have disastrous consequences. The difference in your regular payments will likely be very small. What’s more, you can budget for premiums. It’s much more difficult to prepare for what could be a bill of tens or hundreds of thousands of dollars all at once. New Zealand has shown that it is no stranger to natural disasters in the past decade—from mega earthquakes to volcanic eruptions and tornadoes—so underinsurance is a very real concern.

Even if your building only requires a partial rebuild, underinsurance can sting. “Pro rata condition of average” is something included in many insurance policies, which means the sum paid out—even if only part of the total sum insured, to replace or repair part of the property—will be reduced in proportion to the value of the total sum insured. For example, imagine that your premises were insured for $800,000 but would cost a million dollars to totally rebuild. If you made a claim for a partial rebuild costing $500,000, you would only get $400,000 as you are underinsured by 20 percent. In New Zealand, the Insurance Law Reform Act of 1985 means that insurers must disclose where pro rata condition of average is applied—but it is a technical term that many purchasers may not fully understand.

How do I know if I’m underinsured, and how do I rectify it?

The key thing to remember when deciding on your sum insured is that it should be based on rebuild value and not market value. That means you aren’t insuring for the amount your property would sell for (as this would include the land) but the amount of money it would cost to rebuild the premises entirely. This should take into account structures like retaining walls, pools, fences, and any possible demolition costs.

Understandably, to come up with a sum taking all of that into account is an overwhelming prospect for many business and property owners. Professionals such as quantity surveyors can give the most accurate estimates of rebuild costs, but it is important to check that they are accounting for all the necessary factors and provide as much information as possible. They must be knowledgeable of local labour and supply costs, and be aware of any geographical features and considerations which could impact building budgets. Insurance brokers can help you arrange an accurate valuation from a suitably qualified professional.

Ever-changing construction costs and their impact on insurance

Due to inflation and other cost increases, the sum insured of a property can become outdated reasonably fast. And for busy business owners and employees, updating insurance policies is a tedious task that often gets forgotten.

In New Zealand where housing is in hot demand, building costs can rise sharply. It is important to regularly check your sums insured to make sure that they accurately reflect projected rebuild costs. According to Stats NZ[i], the value of non-residential building consents was up 4.8 percent from 2019, influenced by an increase in non-residential construction prices of 5.4 percent. Those with the highest construction values included education buildings, offices, public transport buildings, shops, restaurants, and bars. Building costs have risen[ii] alongside this, particularly in Auckland. In a report by Deloitte[iii] using statistics collected from 2009 to 2017, a steady increase was shown in the costs of materials, labour, and other contributors.

The advantage of a broker

An insurance broker is not only helpful when it comes to finding the right cover for your business. They can also help you with risk management, valuations, and claims alongside ensuring your policies are up-to-date and represent the best option for you or your business. This includes arranging regular reviews of your insurance programme, to ensure all your risks are covered where possible

Primesure insurance can help you to find and manage insurance for you and your business. Take that task off your to-do list and leave it to the experts! Our team, located in offices across the country, is dedicated to helping people and businesses maximise their insurance dollars. If you’re unsure whether your business premises are fully covered should you need to make a claim, get in touch with Primesure. We’ll help you to assess your cover and make sure you’re prepared for anything that might come your way.

[i] https://www.stats.govt.nz/information-releases/building-consents-issued-january-2020

[ii] https://www.stats.govt.nz/news/construction-costs-rents-and-rates-rise

[iii] https://www2.deloitte.com/content/dam/Deloitte/nz/Documents/Economics/nz-en-DAE-Fletcher-cost-of-residential-housing-development.pdf

Blog Credits: Runacres Insurance