The Rising Threat of Underinsurance: How is Inflationary Pressure Affecting the Property Sector?

By Jason Oldham ACII, Client Service Director at Pi-Property Insurance.

Cooperation is no bad thing, unless we’re talking the rise of inflation. Amidst the turbulence of recent years inflation and underinsurance have proceeded to align within the property sector, and this poses a significant threat.

Since the official withdrawal in 2020, Brexit has paved the way for various UK construction issues, and the following pandemic formed uncertainty for businesses worldwide. Whilst many have persevered or are otherwise combating the knock-on effects, the introduction of rising premiums has entered the mix; pressure has grown on all accounts, desperate times have called for desperate measures, and often lead to poor judgement in the absence of advice.

When faced with increasing costs, it can be tempting to shop elsewhere. Property owners could be forgiven for searching for deals, but without the right type of professional guidance, lower premiums could 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 July 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 rising inflation, the construction and property sectors were already attempting to manage a significant level of disruption. Brexit resulted in labour shortages, whilst the demand of materials outweighed supply, and the cost of desired materials rose. The pandemic subsequently built upon these existing issues; affecting the global supply chain, prices, and in unfortunate circumstances, has caused businesses to enter administration. The impact of the latter has given risen to delays in construction work, and in worst cases, project cancellations.

Global demand is unlikely to change in the foreseeable future and has been likewise impacted by the war in Ukraine. Raw materials have and will become difficult to source, whilst pricing increases are anticipated for cement, concrete and mini steel products. The issues are intrinsically linked, and their outcome points to higher rebuild costs.

Add inflation and greater costs of living to this complicated mix, and the results seem all too clear. Challenges and disruptions can and will occur, 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

Whilst we cannot offer a quick solution to inflation, reducing the risk of underinsurance caused by inflation is very much 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 suitable inflation protection for customers’ insured properties and is automatically updated in line with economic changes when the policy renews.

So how do insurers arrive at these figures? Through thorough utilisation of data. Figures are supplied by the BCIS (The Building Cost Information Service), who are part of RICS (Royal Institute of Chartered Surveyors) to draw upon the cost for labour, materials and professional fees. Alongside the numbers provided, insurers rely upon the Association of British insurers, and the Office for National Statistics to better inform their calculations.

Please note that index linking is not 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

In order to apply index linking, an accurate rebuild value is vital. This can be carried out in person via a survey, or using a 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. In light of current times, some valuation firms are recommending a desktop valuation exercise every six months, ensuring greater peace of mind and accurate index linking.

To avoid complications in an already challenging environment, it is important to know 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.

Furthermore, as mentioned previously, the availability of materials and labour is greatly impacting the industry and plays a big role in delaying the time taken to reinstate a property. 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 is also something to take into consideration and should be 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

We acknowledge that the cover requirements outlined above, and their associated increased premiums, come at a difficult time. Customers are feeling the squeeze at home and in their business, and the odds of underinsurance only 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 to see 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. Recall the advice on desktop valuations. 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.

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