We are continuing our series of insights relating to key risks facing the Real Estate sector. Greg Spiteri, our Head of Sales and Marketing for the Real Estate Division, discusses the key area of Underinsurance and the impact on buildings insurance policies for property owners and managers.
Did you know that over 60% of properties were underinsured in 2018 by as much as 20% or more?
Stackhouse Poland Real Estate Division has a strategic partnership with Cardinus Risk Management who are specialists in Reinstatement Cost Assessments (RCAs). Cardinus undertook 2,200 RCAs last year and found that 67% underinsured at an average of £600,000. This issue has been around for many years, yet the problem remains. Regrettably, all too often, the implications are only fully understood when a major claim occurs. With costs of rebuilding rising year on year, regular RCAs are vital to avoid the consequences of underinsurance in the event of a claim.
The implications of underinsurance
The implications of underinsurance can affect individual buildings and property portfolios in a number of ways:
- Claims payment does not cover the full repair/rebuild cost.
- Funds may not be available to complete the rebuild.
- Increased borrowing costs may be incurred.
- Negative impact on balance sheet.
- Complex negotiations with insurers.
- Dispossessed leaseholders and tenants.
- Extended rebuild period.
- Exposure to potential legal action for inadequate levels of cover from lenders and leaseholders.
- Brand and reputational damage.
Consider a building with a current sum insured of £3.6M. If we assume the rebuild value was actually £4.32M, i.e. 20% undervalued) and a claim was made at a cost of £2.5M the policy would not pay out in full. If insurers had an average clause applicable in the policy, the cover is only 83.33% of the correct rebuilding cost and therefore settlement could be reduced accordingly i.e. £2,083,250 in this instance. The shortfall of £416,750 would have to be met by the landlord or collectively by leaseholders.
Depending on who is responsible for placing the buildings policy, they in turn could be called to task for effecting inadequate cover. Possibly an issue for Professional Indemnity Cover?
How does a building become underinsured?
Underinsurance can be an issue due to many factors:
- Developers reinstatement costs are adopted instead of the true reinstatement cost.
- No recent professional valuation undertaken.
- Sums insured based on notional market value.
- Incorrect estimation based on historical information.
- No allowance for fluctuating costs of raw materials and labour.
- Reliance on developer costs that do not factor in demolition, architect, local authority requirements in the event of a rebuild or VAT.
Stackhouse Poland advise their clients to ensure that the “Average Condition” is removed by ensuring a revaluation programme is in place with documentary evidence. Insurer’s requirements vary but usually a 3-5 year cycle is adequate to satisfy the condition waiver. This means that the risk of average is removed and thus protecting the balance sheet concerned.
Should I include VAT?
This is often seen as a contentious issue and one where there is generally a lack of consistency in approach. VAT notice 708: Buildings and construction (July 2018) gives an interpretation of the law in connection with construction works from the perspective of HMRC. VAT tribunals and court decisions will affect the application of the law since the date of publication in certain circumstances.
The notice is available on the HMRC website.
You should also consider the VAT status of the policyholder and/or claimant. Many property owners are not registered for VAT. In this scenario it is expected that they will want to recover VAT on material and labour costs as part of the reinstatement as they cannot claim back this aspect from HMRC.
There are therefore three main considerations:
- What is the occupation/proposed occupation of the property?
- What is the VAT status of the client/insured?
- What is the insurer’s position relative to the application of VAT?
What is an RCA and why do I need one?
This is a professional valuation which provides a complete assessment of the property rebuild costs. It is vital to protect the balance sheet and avoid underinsurance by removing the average condition in your buildings policy. This is done by ensuring you have a comprehensive revaluation strategy.
An RCA takes into account:
- unusually shaped buildings;
- unusual locations;
- listed buildings;
- buildings with unusual fixtures and fittings;
- use of unusual building materials;
- demolition costs and professional fees; and
- VAT costs where appropriate.
The standard practice is to carry out an RCA every 3-5 years, often with an intervening annual desktop assessment to ensure full protection and mitigate underinsurance risk.
- Adequate protection of the building.
- Removal of average condition from the policy.
- Can reduce premium rates.
- May improve borrowing based upon increased asset values.
- Costs rechargeable to the service charge.
- Reduction in the risk gap – better balance sheet protection.
When you move into a brand-new apartment it is, perhaps, reasonable to expect no hidden increased costs. That was certainly the view of a group of RMC directors whose 200 plus unit building had only been handed over to them some 18 months previously. The directors had taken the sensible step to have a professional valuation conducted and also instructed that VAT should be included for rebuilding costs, debris removal and professional fees.
A declared value of £29m was provided. The surveyor attended site and completed on-site measurements as well as validating these with scale plans provided by the directors.
A reinstatement cost assessment report at £56m including VAT was released……a shortfall of £27m and a considerable shock for all concerned, especially the almost doubling of the insurance premium for each of the residents!
Clandon Park had been in the Onslow family since 1641, a family being noteworthy for having provided three Speakers for the House of Commons. However, the 4th Earl negotiated the transfer of the property to the National Trust when upkeep and maintenance became a burden. This fine Grade I Listed Palladian style house boasted an elegant exterior with pleasing lines and many magnificent internal features.
Unfortunately, in April 2015 a fire broke out, which spread rapidly and caused catastrophic damage. It is estimated that 95% of the property was fire damaged in the conflagration. Forensic investigation determined the fire to be electrical in origin, with the probable cause being a defective distribution board in a services cupboard in the basement. Whilst a significant number of valuable contents items were saved, it is believed that the Insurers will incur a cost of some £65m with the shortfall to be covered by supporters and donations.
To provide an indication of the level of the shortfall, the plan announced is for there to be a faithful restoration of the ground floor, with upper floors being reinstated to a sympathetic but modern specification.
In previous articles we have unashamedly championed the importance of the right team for the right job. At Stackhouse Poland we take our partnerships very seriously through rigorous selection processes. We have chosen to work with Cardinus who work with us to provide the right solution for RCAs for our clients.
Cardinus is a RICS regulated company with over 20 years’ experience of providing quality assured expertise. They have a team of UK-wide professionally trained surveyors carrying out over 10,000 surveys and assessments each year for both property owners, retailers and insurance markets.
It is essential not only to be aware of the issues involved in managing your property portfolio risks, but seek professional guidance on the type of solutions available and how this impacts your property insurance programme. Ultimately, this will protect your balance sheet and also avoid unnecessary gaps in cover that not only expose your programme but have a detrimental value on reputation and brand value.
Find out more
If you would like to talk to us at greater length about this, or any other aspect of Real Estate, please complete our Contact Us form or email us at Realestate@stackhouse.co.uk.