Why You Need A Reinstatement Cost Assessment Strategy ASAP
07/11/2024
“The most expensive insurance policy you will ever buy is the one that does not pay out.”
Underinsurance is a universal problem when it comes to commercial properties and developments. The shock of Brexit, high inflation, and the Ukraine/Russian war have skyrocketed prices related to building materials and labour. At the same time, skill shortages and ever-shrinking budgets in the private, public, and third sector mean a substantial number of commercial property portfolios currently have potentially disastrous levels of underinsurance.
Underinsurance occurs where the sum insured, which is the customer’s responsibility to provide, is insufficient against the actual reinstatement value of the risk.
To solve the problem of a chronically underinsured or overinsured property portfolio, a Reinstatement Cost Assessment (RCA) must be conducted across all properties. One of the challenges faced by organisations is that this can be a costly exercise. However, underwriters have made clear that their patience regarding underinsurance is rapidly wearing thin. For this, and other reasons explored below, your organisation must act now to ensure your property portfolio has adequate insurance coverage.
Why are there so many underinsured properties?
Between 2020 and 2023, Britain and much of the world were dealing with the challenges of the Covid-19 pandemic, soaring inflation, and the effects of the Russia/Ukraine war. This led to prices for material and labour rising rapidly.
Although inflation dropped to 2% in June 2024, the industry faces new challenges. According to the Building Cost Information Service (BCIS) General Building Cost Index 1Q2024 to 1Q2029:
• Materials prices are expected to rise by 15% over the next five years and tender prices will rise by 17% over the same period.
• New work output fell by 2.1% in 2023 compared with the previous year. This is predicted to contract by a further 3.2% in 2024 before returning to growth.
• Over the forecast period (2024-2029), total new work output is forecast to grow by 21%.
• The cost of borrowing is affecting new work, especially in the private sector, where investment is adversely impacted.
• New orders data, which indicates the number of new projects and volume of work available is trending down.
• The Government’s construction plans remain ambiguous.
There is positive news. Annual growth in the BCIS Labour Cost Index is forecast to grow by 18% between 2024 and 2029. Site rates have been rising in line with inflation, and the rate of annual labour cost growth is expected to slow.
Dr David Crosthwaite, Chief Economist at BCIS, commented on the data, stating:
“Although firms are generally reporting stable materials prices, everyone is watching what happens in the Red Sea and the Middle East. Even where there’s not a direct inflationary effect on prices because of the delays or hikes in shipping costs, we’re hearing that the increased risk is being factored into prices.
‘After lurching from what seems like one crisis to the next, the industry is still dealing with a lot of uncertainty. Even if the UK economy comes out of recession straight away, this persistent low growth seems to have become characteristic, and it’s the same in construction.”
Any property portfolios that have not had a Reinstatement Cost Assessment completed in the last five years risk being underinsured.
What are the risks of not having regular Reinstatement Cost Assessments?
Aside from the risk of being underinsured and the financial implications of being in such a position, having properties that have not received an RCA and, therefore risk being underinsured or overinsured are not attractive when it comes to inviting tenders.
Investors and buyers who discover underinsurance or risk of underinsurance during due diligence may also decide not to go ahead with the deal or use the information to negotiate down the investment funds or purchase price.
Will the average clause protect me against underinsurance?
Not necessarily. Average is not a protection against underinsurance. Instead, it protects the insured party against inflation-related cost increases during the time between the loss suffered and reinstatement of the building.
If you can show that your organisation has conducted regular RCAs, the average is likely to apply because you can demonstrate you have mitigated your risk of being underinsured.
What are the barriers to getting regular Reinstatement Cost Assessments?
Cost is typically the main obstacle to getting RCAs completed every three years (in addition, inflationary impacts should be investigated annually), especially in the case of councils and large corporations that hold thousands of properties in their portfolios. In addition, the methodology of conducting an RCA can be tricky. The assessor must understand elements such as demolition costs, VAT, and the true cost of labour and materials.
How Zurich Resilience Solutions can help
We offer a tailored approach to RCAs to help customers return to a healthier position. For example, we can split RCAs over two to three years to assist with budgeting. Once your property portfolio’s RCAs are up to date, we can implement a long-term plan to ensure the process occurs regularly and the risk of under or over-insurance is effectively eliminated.
To find out more, download our Building Reinstatement Valuation Risk Guide and do not hesitate to contact us with any questions.
