Co-operation is no bad thing, unless we’re talking the rise of inflation. Amid the turbulence of recent years, a partnership of inflation and underinsurance has emerged in the property sector and poses a significant threat.
Since January 2020, Brexit has paved the way for numerous UK construction issues, while the subsequent pandemic heightened uncertainty for businesses worldwide. Though many have persevered or are otherwise combating the after-effects, rising premiums have entered the mix. Pressure has grown on all accounts – desperate times call for desperate measures, and often lead to poor judgment in the absence of advice.
When faced with increasing costs there’s a temptation to shop elsewhere. Property owners could be forgiven for hunting deals but opting for lower premiums may result in underinsurance, and greater costs at the time of a claim. In a recent review conducted by Allianz, almost 50% of policies had a building sum insured less than 80% of the rebuilding estimate, illustrating that underinsurance is already widespread and will grow in tandem with inflation rates.
Inflation and rebuild costs
In June 2022, the BBC reported that UK inflation rose to its highest rate in 40 years, but what does this mean for rebuild costs?
Prior to growing inflation, the construction and property sectors were already managing a significant level of disruption. Brexit resulted in labour shortages, demand of materials outweighed supply, and the cost of materials rose. The pandemic consequently built on these issues, affected the global supply chain, and forced businesses to enter administration. This in turn has caused construction delays or even project cancellations.
Global demand is unlikely to shift and has been impacted by the war in Ukraine. Raw materials remain difficult to source and price increases are anticipated. The issues are intrinsically linked, and their outcome points to higher rebuild costs.
When we add inflation and costs of living to the equation, the end results become clear. Challenges will arise, but in the face of adversity solutions remain. With careful planning and the right professional advice, we can prevent the risk of underinsurance created by inflation hikes.
Index linking
While there’s no quick solution to inflation, reducing the risk of underinsurance caused by inflation is within our capability, and index linking forms the core of this process. Simply put, index linking is applied to calculate the difference between the sum insured and the rebuild value of a property, ensuring that an asset’s insured value is in line when changes (such as inflation and high cost of living) occur. Insurers’ recommended indexation provides a form of inflation protection for customers’ insured properties and is automatically updated in line with economic changes when the policy renews.
Insurers arrive at these figures through thorough use of data. Figures are supplied by the Building Cost Information Service, which is part of the Royal Institution of Chartered Surveyors, to draw on the cost for labour, materials, and professional fees. Insurers also rely on the Association of British Insurers and the Office for National Statistics to better inform their calculations.
Please note that index linking isn’t a replacement for regular rebuilding cost assessments undertaken by a professional member of the RICS. Where this is part of a three-year programme carried out on the insured’s entire property portfolio, then insurers will waive the application of average. This demonstrates to insurers a regular and disciplined sum insured review has been undertaken.
The importance of rebuild valuations
To apply accurate index linking, a rebuild value is essential. This can be conducted via an in-person survey or desktop device and entails a RICS qualified valuer (for insurance purposes) to calculate rebuild costs from the ground up if a property is destroyed by fire. To ensure peace of mind and precise figures, some valuation firms are recommending a desktop valuation exercise every six months.
To avoid potential complications, it’s important to understand that such valuations are not to be confused with a market valuation, or a mortgage valuation, as they are unsuitable for the arrangement of an appropriate sum insured for insurance purposes.
Attention must also be given to the business interruption protection provided under an insurance policy with regards to loss of rent receivable or payable. This would be reflected in an increase to the indemnity period and the sum insured under the business interruption section of the policy.
Arranging insurance on a non-adjustable basis
You’ve conducted your rebuild valuation and indexation can be applied. You can be assured that the risk of underinsurance is slim, but more can – and should – be done.
The arrangement of insurance on a non-adjustable basis must be considered and discussed with a property insurance specialist broker. Under a bespoke property owners policy, this clause can provide additional protection from the effects of inflation on rebuild costs after a claim has occurred.
Prevention is key
The cover requirements outlined above (and their associated increased premiums) have emerged at a difficult time. Customers are feeling the squeeze at home and in their business, the odds of underinsurance complicate matters, but prevention is entirely possible.
Step one in this process is to seek the right help from the start. Use a specialist property insurance broker for advice and guidance on avoiding underinsurance and consider the re-evaluation of all insured property by a professional member of the RICS.
When it comes to your insurance policy, check if it contains an average waiver condition and consider longer indemnity periods under your business interruption section for loss of rent payable or receivable.
Thirdly, think frequency. Regularly review your sums insured, ensure that declared values are index linked annually, and see that non-recoverable VAT is included in the building declared value provided to your insurer.
In the face of current pressure and rising inflation, providing all the necessary details can feel overwhelming, but remember prevention is key and preferable to underinsurance. Talk to your insurers, seek their advice, and know that support is always on hand.
Jason Oldham is a client service director at Pi-Property Insurance
