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| Insurance Matters #2: Property Insurance Values |
“How much should I insure it for….?”
My client leaned forward attentively in his chair facing my desk. We were discussing the Insurance on a new house he was buying. The Bank that provided him with his mortgage had sent him to us. They had not given him any advice as to how much he should insure his new building for, and that was the question facing us now.
“Well its solid concrete and I know it wont burn; neither is it likely to be seriously damaged by a hurricane- so why don’t we just insure for the amount of my mortgage? That way the bank’s interest is protected, and the cost to me is minimized”, he suggested.
“A dangerous misconception”, I replied.
“You see, there are severe penalties for underinsuring your building, and if I do as you suggest your settlement in the event of a claim, could leave both you and your bank out of pocket”.
How then, do you decide on a Sum Insured for your property? Most Homeowners Policies provide you with cover on a Reinstatement, or New for Old Basis. It sounds very attractive but there are hidden obligations. The Policy requires you to insure for a value that will cover reinstatement…at the time that the building is rebuilt. You will also be covered for Removal of Debris in the event that your existing building has to be demolished, and the Architects, Surveyors and Consulting Engineers fees associated with your rebuilding following a severe loss. But…your sum insured must be sufficient to cater for those costs. Similarly, policies usually contain a Local Authorities clause in the event that the Planning Authorities require you to change the specifications of the original structure; a situation that could leave you with additional costs. Again, it’s fine, as long as long as your Sum Insured is sufficient to cover those costs. It’s relevant to state here that after binding you to these obligations, very few Insurance Companies will tell you what you should insure your home for. They will tell you that they are not property valuators, and that the onus is on you to determine the value of your home.
If you are like my client, and have just been offered a mortgage, you will probably have had to have your property valued and some valuation reports include an Insurance Value. Otherwise you could have your home valued by a professional valuator but this can be expensive. Another rational way would be to call a few builders and get an idea of the current building cost per square foot of a house with the same construction and finish as yours. Remember to cater for the foundations and cistern. Then add a percentage for planning and debris removal, and multiply the square footage by the building cost per square foot. I must add that this is a very rough method, but it will give you an idea as to whether your Sum Insured for rebuilding your house is realistic. Naturally, you should exclude the land value from your assessment, and very few companies will cover landscaping, so you are likely to find that the cost of replanting your garden will fall outside the scope of your insurance cover. Swimming pools and outbuildings are usually optional; in my opinion it’s best to insure all the insurable structures on your land. There are good reasons for this, one of which is that it minimizes the possibility of complications arising in the event of a catastrophic loss at your premises.
I previously mentioned the penalties contained within your policy for underinsurance. Most policies contain an Average Clause, the effect of which is to make the policyholder responsible for a proportion of the loss in the event of underinsurance. These days, this is usually incorporated within an 80% condition of Average.
Here’s how it works:
The rebuilding value of your home is $100,000. You have insured it for $70,000. You are 30% underinsured. You lose your roof in a fire and repairs cost $20,000. Because you are more than 20% underinsured, you will only receive a ratable proportion of your loss- in this case 70%, or $14,000. You are out of pocket by $6,000.
At a time like this, when Insurance Premium rates on buildings are high, it is tempting to underinsure, but there are other, more effective ways of reducing your premiums. You can discuss these options with your Insurance Advisor.
One last point; the Market Value of your property should have no effect on its Insured Value. You are covering the cost of rebuilding and this is normally not affected by the situation or status of your location!
Tony Lancaster |
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