Under-Insurance Risk For Commercial Property

The unrelenting rise in construction costs over the past year, with some materials increasing by as much as 100 per cent, has left many commercial properties under-insured.

Last month we explored how construction cost rises were posing a risk to homeowners, whose buildings sum insured may not be sufficient to cover rebuild costs in the event of the home being badly damaged or destroyed altogether. The problem is equally prevalent within the commercial sector, with the risk of commercial property being underinsured having increased considerably for the same reasons.

What’s happened to construction costs?

Brexit, the pandemic and a surprise surge in renovation works have all combined to create supply chain problems and shortages across the labour market.

Critical parts and materials are in short supply due to escalating shipping prices and delays at British ports. Shortages of the likes of plaster, concrete, insulation and power tools have spiked in recent months.

The Builders Merchants Federation (BMF) has reported that product and materials prices have surged by between 10 and 15 per cent this year, that timber has gone up by as much as 50 per cent, and that certain types of sheet materials have soared in price by 100 per cent.

The RICS BCIS (Building Cost Information Service) general building cost index is used by insurers for index linking the commercial property sum insured between annual policy revisions, and for updating the sum insured each time the policy is renewed. This is intended to ensure that any original declared value for rebuild purposes increases in line with economical changes. However, whilst the index was forecast to increase by almost four per cent between March and September 2021, it still remains unlikely such a rise will cover such significant increases in rebuild costs, which is why under-insurance is becoming more of a risk for commercial property owners.

Why is it so important to insure your commercial property for the correct amount?

Under-insurance can have serious consequences. Insurance policies normally contain something known as the ‘Average Clause’, which means that, if the sum insured is less that the value at risk at the time of the loss, the claim will be reduced in the same proportion.

To illustrate this, say a property is insured for £1,000,000, but the actual cost to rebuild is £2,000,000. Any insurance claim made on the property could be reduced by 50 per cent. This means you would need to find £1,000,000 yourself to cover the cost of rebuilding your property following a major incident, such as a fire that destroys the entire building. Few companies would ever be able to afford such an amount, which could send them out of business.

Around two thirds of commercial properties are said to be under-insured, and covered for only two thirds of their correct rebuild cost.

What is the solution to avoid the consequences of under-insurance?

The simple solution is to insure for the correct amount. But how to accurately ascertain what this is?

You could engage a chartered surveyor to visit your property and undertake a professional assessment. There are fairly high costs involved in this method, however.

The alternative is to opt for an online reporting service. This can be arranged by your insurance broker, or directly with a report provider.

The report is carried out remotely, so there is no disruption to your business. It is based on rates for commercial property taken from the RICS BICS service. These are subject to indexation adjustments every fortnight, which takes into account up to date increases in material and labour costs.

This type of report advises you of the rebuild cost of your property. Providing the report is carried out by a Royal Institution of Chartered Surveyors (RICS) regulated company, some insurers will remove the Average Clause from your policy as long as you insure for the amount recommended in the report. If a claim situation arises, then you will have the reassurance of a RICS report to back you should there ever be a dispute.

Is your commercial property adequately insured?

It is vital to make sure your commercial property is adequately insured. If it isn’t, and it was seriously damaged or destroyed, you could face only receiving a proportion of the rebuild costs. Few businesses would be able to recover from such an incident.

If you have concerns over whether your commercial property insurance is sufficient to fully cover a rebuild in light of the recent surge in construction costs, which is showing no sign of abating, please do get in touch with your regular contact at Robert Gerrard. If you wish, we can arrange with one of our RICS regulated property valuation partners to have your property’s rebuild cost evaluated. This service can either be provided remotely, or via a site visit if preferred. Please do let us know how we can help.