Many Australians, especially those who own businesses, discover they don’t have the cover they need in the worst possible circumstances – when they need to claim. In this article we will deep dive into some of the issues we are observing due to businesses not having the correct building and contents replacement values. We will also discuss an important insurance clause, which could be applied to your claim.
In 2021, building materials rose by an average of 30%, however we find businesses are either not increasing the building and contents replacement values at all, or they are applying inadequate minor increases, which leaves the property and business owners financially exposed.
To give you some examples behind some of the material increases we have seen:
- Steel costs have risen by 50% in recent months
- Framing timber & treated pine cost have doubled
- Shipping container freight costs from Asia have risen by 300%
- Plant & Machinery wait times can be between 3 to 12 months
You have insurance, however do you have the correct Sums Insured or Limits?
Within Property Damage & Business Interruption insurance policies, there is a clause known as the ‘Under-insurance’ or ‘Co-insurance’ or ‘Average’ clause. This clause limits the amounts payable under a claim if the sum insured on the property is understated. Depending on the policy, the property must be insured for a certain percentage of the replacement value (usually 80% or 85%). However, replacement value does not mean what you paid for the property, it means the actual cost to demolish and rebuild damaged building structures or the replacement cost for new machinery, fittings & contents.
Each insurer allows this 15 – 20% margin to account for fluctuations in construction costs & in recognition that you are not a professional valuer. If you are within the margin & suffer a partial loss to your assets, the clause will not apply & you will receive full settlement of the claim cost. However, if you suffer a total loss, then your settlement will be limited to your Sum Insured. Your task, therefore, is to set the most accurate Sum Insured which reflects the replacement cost of your asset. To assist in setting the Sum Insured, we recommend the use of licensed valuers or, at a minimum, the use of an external person with knowledge on costings (Commercial Builder, Estimator, etc.).
The above may sound a bit confusing, so the following example should help demonstrate the concept
Let’s assume the sum insured for a building is declared by the insured at $1,500,000
But the actual total replacement value for the building is actually $2,000,000
For the purpose of underinsurance calculation 85% (of $2m) equates to $1,700,000
$1.5M is less than $1.7M. Therefore, the under-insurance or co-insurance clause will apply to the settlement of the claim.
The building suffers partial fire damage with a repair cost of $500,000
Settlement Amount:
Actual loss ($500,000) times Declared value ($1,500,000) divided by 85% of actual replacement ($1,700,000)
Insurer will pay out $441,176
Leaving the insured to pay $58,824
The more the policyholder is underinsured, the more the policyholder has to pay (contribute) to the loss. Note, if the building was destroyed, the loss would be $2M & the insurer would pay $1.5M (the Sum Insured) in settlement.
How do these shortfalls occur?
Here are some of the common errors made are in:
- Under estimating the replacement cost of a building by using an outdated cost per square metre
- Not having an accurate floor area &/or ignoring carparks & hardstands
- Not including or having insufficient cover for removal of debris costs (especially if asbestos is present at the situation)
- Not including or having insufficient cover for increased costs and inflation
- Under estimating or not taking into consideration heritage or council preservation orders or, alternatively, additional costs to comply with current building regulations (e.g., costs for disabled access & amenities, fire resistance building materials, etc.)
- Not including architectural and engineering fees in a building sum insured
- Not including or having insufficient cover for replacing contents, stock, plant and machinery (using ‘book value’ or depreciated values when cover is ‘new for old’ replacement)
- Not reviewing and increasing sums insured at least annually
- Failing to include business interruption cover or at least Additional Increase Costs of Working (AICOW) cover
- Setting an inadequate business interruption indemnity period
- Not keeping up to date with replacement value of plant and equipment
Trident Insurance Group has access to leading industry tools and calculators which can be of great benefit to you, your business and your insurance program.
What are some tips to prevent underinsurance from happening?
Tip 1
Gain independent advice. While on line calculators for Domestic Buildings abound, free commercial calculators are rare & very general. Talk to your insurance broker (who should have access to a Commercial Building Calculator) or request an Insurance Valuation from a licensed valuer.
Tip 2
The above Building estimate needs to be adjusted depending on your property – are you on flat land or sloped? Is access easy or difficult? Increase your Sum Insured for potential difficulties in repair or rebuilding but don’t reduce the Sum Insured if ‘easy’.
Tip 3
You’ve calculated your estimated Building cost & made adjustments for your individual circumstances. To finish, check that the following items have been included in the Building cost calculation:
- GST (if applicable)
- Removal of Debris
- Professional Fees (Architect, Engineer, etc.)
- Cost of temporary accommodation
We would recommend, as a rule of thumb, that 10% of your rebuild cost should be added for each of these items.
Add all the figures together & you get your Building Sum Insured.
Tip 4
Business Contents are split into:
- General Contents, Machinery, Plant & Equipment – these items should appear in the Asset Register of your business.
These items need to be insured on a ‘new for old’ basis. For substantial pieces of machinery, research the web to determine replacement value – the result may surprise you!
- Stock
This is to be valued at Indemnity Cost (not retail value). Most businesses will have fluctuating Stock levels so insure for your ‘high’ point not your average value.
Tip 5
Most insurer’s standard Business cover will limit material loss or damage to your situation. You may need an additional policy to cover items away from your situation (General Property). We recommend discussing your individual needs with your insurance broker to tailor your cover to your needs.
Tip 6
Understand your policy & the terms of cover by talking to experts – many policies include additional benefits that will cover removal of debris & professional fees in addition to the Sum Insured. You can increase these as needed for your individual circumstances.
Business Underinsurance – Summary
It is believed that business underinsurance is highly prevalent in Australia. The Insurance Council of Australia believes that one in eight businesses are not insured & a further 10% are underinsured for their assets.
By working through the tips provided, you will not only avoid underinsurance, but will also obtain the added financial security that your business requires.