In this article we explore how to identify underinsurance and mitigate this risk in your organisation.
- Understand the insurance New Replacement Value of a building
A building’s market value is irrelevant for insurance purposes, and its use for building sums insured is a frequent source of underinsurance. Buildings sums insured need to reflect the full cost of reinstating a building following a total loss. In addition to materials and labour, this includes all associated costs such as demolition, debris removal, planning and professional fees. Each building will have features that can significantly alter a reinstatement cost, such as difficult site access, period features or specialist construction techniques.
A ‘building’ applies not just to a main structure but includes features such as foundations, boundary walls, drains, underground cabling, landscaping, car parks and outbuildings. Not including such features is a frequent source of underinsurance. Precisely what is included will be defined in your policy wording. Not allowing for VAT is another widespread problem. The building should be insured inclusive of VAT. Insurers in Botswana settle claims with VAT included and policyholders are obliged to pay VAT out of the claim amount.
There is always some salvage value by example; professional fees, boundary wall, paving, P&G costs being an amount allowed for contingencies, foundations following a fire loss of a building which will impact on the settlement figure. Using a “best guess” to estimate the true costs of the reinstatement of a building may not be sufficient at the best of times, but such an assessment is now made more difficult by the uncertainty created by the pandemic.
Before setting up an insurance New Replacement Value of a building the policyholder needs to consider:
- External items – driveways, boundary walls, gardens, car parks, drains
- Demolition, debris removal, protection of surrounding sites or party walls
- Changing regulations – rebuilds may now need to factor in features such as disabled access, reduced environmental impact or improved fire protection
- Site geography – access difficulties, protecting surrounding buildings, state of underlying land
- Professional and administration fees, such as architects, lawyers, surveyors, and planning applications
- Plant and Machinery –availability, logistics and exchange rates
Plant and Machinery under fire policy is usually insured on a New Replacement Value basis. These items can be particularly susceptible to depreciation, so it is particularly important to approach valuations on the correct basis. Where the items are still readily available, determining values should be relatively simple. However, for older or difficult-to-source items, you may need to base valuations on alternatives of a similar type, capacity, and utility. If dealing with large, specialist or bespoke pieces, there are likely to be a variety of additional considerations, such as costs for design, manufacture, installation, and commissioning. Speak with potential suppliers to understand the current cost of meeting your needs. If sourcing items from overseas, some contingencies should be included for potential currency fluctuations, as even small fluctuations can have a large overall impact on high-value items and the increase in cost of transport worldwide due to the pandemic needs also to be considered when setting sums insured.
As with buildings, valuing Plant and Machinery accurately requires specialist knowledge and experience. For organisations with capital intensive equipment, or for those that heavily rely on such items for their day-to-day operations, it is especially important to conduct regular professional valuations.
- Conduct regular reviews of insured items’ sum insured
Property values do not remain static, and sums insured need to stay under continual review to remain accurate over time. A thorough review of all sums insured should therefore be conducted at least annually, typically at renewal. However, this does not necessarily mean paying for full professional surveys each year. Most surveyors will recommend conducting a full valuation at least every three years, with annual desktop appraisals in between. These desktop appraisals allow surveyors to apply their knowledge and expertise to an organisation’s unique circumstances, and update valuations accordingly. Remember, values can go up or down. Regular reviews will also help you avoid paying for cover that is beyond your organisation’s needs.
- Setting up maximum indemnity period (s) under Business Interruption Insurance
Be very careful to check your indemnity period on any business interruption policy. A common oversight with cover for business interruption is that the period of cover selected to protect the business financially turns out to be far shorter than the actual period of disruption. This then leaves the business with ongoing losses after the insurer stops paying – for example if you need to continue renting business premises beyond the indemnity period set.
The recovery process may take longer than you think – even small, straightforward businesses can need longer than 12 months’ protection. If you are rebuilding premises for example, you may require planning permission which can often take months before any rebuilding works can even begin.
Finally, there is the impact that all these issues are having on active insurance claims. The loss adjuster’s job of assessing the losses immediately after the insured peril has occurred has perhaps never been as important, or difficult, as it is now. It is important that loss adjusters take the issues of supply chain shortages and increased costs of materials into account to enable them to set accurate reserves for insurers at the outset of claims and to enable insurers to take all policy coverage issues into account.
With businesses under severe economic pressure from COVID-19 plus a range of other issues, insurance experts have warned that clients may be tempted to sacrifice cover to reduce their insurance spend. While underinsurance has been a challenge for a long time, the current economic climate combined with the hardening market has pushed it higher up the agenda.
Businesses and individuals need to be extra-vigilant to the risk of underinsurance and understand the nuances involved when determining one’s own sums insured. Should sums insured not be appropriately determined one may well find themselves under insured at the time of a loss and having to fit the bill for any settlement shortfall which may result in a business having to close and/or property having to be sold.