Valuation & Underinsurance - are Scotland’s Council’s fully covered?

Valuation and underinsurance: are you covered?

Paul Latham Client Development Executive Public Sector & Education Gallagher’s (logo style) Although not a new phenomenon, underinsurance remains an ongoing concern in the insurance market. The hardening attitudes of underwriters is seeing property pricing increase and claims being settled in strict accordance with policy wordings. This change has been driven by global factors and more local events such as the tragedy of Grenfell.

Policyholders may not realise that underinsurance may have a direct impact on the claims payments they may receive in the event of a property damage claim.

What impact can underinsurance have?

If a claim payment does not cover the full property repair/ rebuild cost or reinstatement, it could mean funds may not be available to complete the rebuild. This may result in:- • Unbudgeted call on reserves • Protracted and complex negotiations with insurers; • Discontented stakeholders such as leaseholders and tenants which may result in legal action • Extended rebuild times with an impact on service delivery; • Damage to reputation within the community

How does a building become underinsured?

Underinsurance can become an issue as a result of several factors:-

• Reinstatement Cost Assessment was completed many years ago with a reliance on insurer’s index-linking ever since. • A reliance on insurer’s valuation when changing insurers. Insurance valuations are generally not transportable between insurers due to the methodologies used. • No professional valuation or Rebuild Cost

Assessment has ever been undertaken • Sums insured are based on a notional market value • Incorrect estimation based on historical information • No account has been made for structural changes which may have been made to the building • No allowance for fluctuating costs of raw materials and labour. Availability of materials has a significant impact on their costs, particularly at the moment • Developer’s costs are adopted instead of the true reinstatement cost

around. Buildings are constantly changing value and there is always a risk that if insurance is placed without examining how things have changed, then underinsurance is likely.

The implications of underinsurance

The “Average Clause” is a standard policy condition in UK property insurance policies. In its simplest form the clause allows an insurer to reduce a claims payment by the amount of underinsurance present at the time of loss. By way of example:• Consider a building with a current sum insured of £7,200,000. A fire occurs which damages most, but not all of the property. Loss adjusters are appointed by insurers and they calculate the true rebuilding cost of the property to be £9,000,000 (in other words it was underinsured by 20%). The cost of the loss is calculated to be £5,000,000, but once the insurer applies the “average clause” the claim payment is reduced by the amount of underinsurance (20%) leaving the policy holder £1,000,000 short of the full repair cost.

A regular Reinstatement Cost Assessment could have identified the underinsurance on which the policyholder could have acted.

What is the purpose of a Reinstatement Cost Assessment (RCA)?

Sounds simple, but it is there to establish the likely cost of demolishing and rebuilding all property on site that falls within the definition of ‘Buildings’ as covered by the policy following damage by an insured peril.

With costs of rebuilding rising year on year, regular RCAs are vital in order to avoid the consequences of underinsurance in the event of a claim. The Royal Institute of Chartered Surveyors (RICS) recommends that a Reinstatement Cost Assessment is assessed every three years, or earlier should significant alterations be made to the insured property, with an annual adjustment to reflect inflationary effects

How do you perform a Reinstatement Cost Assessment?

There’s some different options as to how a Reinstatement Cost Assessment can be calculated:-

• An on-site assessment and report • An on-site sampling exercise of properties of similar type within a portfolio (if there are a number) • A desktop assessment and report • A combination of on-site and desktop assessments

Whilst the preference of insurers is to conduct a physical on-site assessment, in some cases it may not be necessary or even financially possible to do so. Desktop solutions have therefore been developed which can be used where:• the footprint of the building is easily identified using digital mapping tools • the property is non-listed • buildings that don’t have basements/ cellars or underground car parks • non-complex elevations or unusual materials

Listed Buildings and the impact to reinstatement costs

Listed buildings present particular challenges when conducting a Reinstatement Cost Assessment and in most cases it is not possible or advisable to rely on a desktop valuation to assess reinstatement values for insurance purposes.

A listed building in the United Kingdom is a building which has been placed on the Statutory List of Buildings of Special Architectural or Historic Interest.

In Scotland listed buildings are categorised A, B or C with category A being afforded the greatest protection. • Category A Buildings of special architectural or historic interest which are outstanding examples of a particular period, style or building type. • Category B Buildings of special architectural or historic interest which are major examples of a particular period, style or building type. • Category C Buildings of special architectural or historic interest which are representative examples of a particular period, style or building type.

All categories require specialist treatment with their management being guided by the Planning (Listed Buildings and Conservation Areas Scotland) Act 1997.2 Failure to comply with the rules governing the management and preservation of a listed building may have financial and practical consequences.

The Act places a responsibility on Historic Environment Scotland to maintain a list of all categorised buildings. Whilst no definitive number is available it is believed that Scotland has 47,000 listed properties3 with Edinburgh having the largest number of listings at over 9,000. These numbers are significant and those responsible for maintenance of a listed buildings should have taken in to consideration the impact underinsurance may have on their ability comply with the requirements of the listing.

New Build or Newly Built Properties

A question that is frequently asked is, “if I set my insurance cover based upon the original development cost of constructing the property then that should be adequate, shouldn’t it?”

Unfortunately, that is not the case and in most instances development costs do not compare well, if at all, with the costs of reinstatement following, for example, a serious fire. There are many factors which make reinstatement costs higher including:• The need for works to commence urgently. • The timescales involved when residents are rendered homeless • Demolition costs • Changed surroundings due to the passage of time • Addition of features and outbuildings post-development • Additional site access costs • The need to protect undamaged sections of a building from the elements • Less efficient work programming requirements • The scale of scaffolding and other access costs • The need to protect and prop adjacent buildings • The differing profile of professional fees • Developer’s costs being set on fixed price tenders, in some cases longer than a year before the first plant is brought onto site • Economies of scale for developers buying materials in bulk not usually replicated in claims situations

Should I include VAT in my valuation?

This is a contentious issue and there is often inconsistency in whether VAT is taken into account and if so by how much.

As an example, the erection of a new single dwelling or residential block is zero-rated for VAT. However, insurance claims are not always zero-rated for total losses and therefore VAT is applicable to rebuilding costs in many cases.

VAT rates on buildings used for religious purpose and historic buildings is another inconsistency example.

In broad-based terms, when considering VAT in relation to calculating a rebuild valuation there are 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?

Consultation with a qualified VAT accountant to obtain the correct position for your circumstances is therefore recommended. This should then be conveyed to the valuer who can ensure the appropriate position is reflected in the RCA report.

Conclusion

It is essential to be aware of the risks involved in managing a property portfolio, but it is also vital to seek professional guidance about the types of risk management and insurance strategies available and how they can adequately help you protect your property.

Ensuring that the correct reinstatement values are used is an essential part of the risk management strategy for an organisation - get this wrong and the services being provided are likely to be affected, including their reputation, which remains a key asset for any organisation.

1. https://www.rics.org/uk/upholding-professionalstandards/sector-standards/building-surveying/ reinstatement-cost-assessment-of-buildings/ 2. Planning (Listed Buildings and Conservation Areas) (Scotland) Act 1997 (legislation.gov.uk) 3. https://www.historicenvironment.scot/advice-andsupport/listing-scheduling-and-designations/listedbuildings/what-is-listing/#listing-exclusions_tab