Review Sums Insured

Failing to update sums insured could put your property at risk  

There’s no denying that the last few years have been difficult ones for anyone involved in property insurance – including property owners. A hard market has prevailed which has seen premiums increase, capacity constrict, difficulties in securing coverage arise, more restrictive terms and conditions introduced, and the need to meet more stringent underwriting criteria imposed.  

The property market has been impacted by numerous factors including supply chain disruptions, shortages of raw materials and finished goods, labour shortages, manufacturing delays, inflation, rising interest rates, higher commodity prices, natural disasters and global tensions (including the ongoing war in the Ukraine and the Israel–Hamas war).  

Importantly, these factors are also affecting the cost of replacing lost or damaged property, including business premises, assets (vehicles, plant, equipment, machinery) and contents (goods, stock on hand).  

With replacement costs rising, there is a risk that a business could find its assets under-insured if property sums insured are not reviewed and updated. 

Protect against under-insurance – it’s a false economy otherwise 

Deliberately under-insuring assets is a risk few can afford to take. While some may be tempted to risk nominating lower sums insured to save on the premium, in the event of a claim, and especially one involving a total loss, that decision can prove to be a false economy. If a policyholder chooses to only insure a percentage of the replacement value, then they are also choosing to take on a percentage of the risk. 

For some, however, under-insurance is unintentional and stems from not working out how much is really needed to cover potential losses, for example by underestimating rebuilding costs (with demolition) or the replacement value of assets.  

The Insurance Council of Australia (ICA) estimates that more than 80% of Australians are under-insured on their properties, while a Business Australia report suggested two-thirds of businesses may be under-insured.  

Underinsurance can have wide-ranging impacts, including creating financial hardship and challenges in the event the payout is not sufficient for the business’ needs. For example, if the business is damaged by flood or fire, there may be insufficient funds available to replace or rebuild the assets. 

Importance of sums insured 

Policyholders are generally required to nominate the property sums insured. The amount nominated should equal the amount of money needed to replace the property and its contents if they are damaged, destroyed or lost due to an insured event. The insurer uses these sums to help assess the risk in covering the property. Once they calculate the risk, they decide on an appropriate premium for the policy, along with the limitations, inclusions and exclusions. 

If the sums insured are inaccurate, the policyholder is at risk of being under-insured, which means they will not have enough insurance to cover the full cost of any loss suffered. 

It should also be noted that most commercial property insurance policies have what is called a co-insurance clause. This enables the insurer to penalise a policyholder for not insuring their building, stock or contents for its true replacement value. The co-insurance (or average) clause reduces the amount an insurer pays out on a claim because the sum insured is lower than the value of the property. 

It is also important to understand that the sums insured are usually the maximum that the insurer will pay out if a claim for an insured event is made. However, most policies or insurers will allow for a safety net of between 15-20%, so if the sum insured is at least 80-85% of the actual replacement cost, the policyholder may not be penalised or asked to contribute. This varies between each policy, so ensure you check the terms and conditions. 

Even with a safety net, if the policyholder has substantially underestimated what it will cost to repair or replace their property, then they will need to make up any shortfall between what their insurer will pay and what it will actually cost to reinstate the property.   

Policyholders need to ensure that their sums insured adequately reflect today’s costs and risks. It is also prudent to review and update expected reinstatement periods for tangible assets to reflect changes in supply chains and prices. Doing this will help reduce the risk of under- and over-insurance, should a claim arise. 

Volatile economic conditions

The last few years have been tumultuous for economies around the globe. Insurance is not immune from macro and micro economic factors and the prevailing conditions can greatly influence the availability and cost of covers. These factors can also have a significant impact on the policies a business currently has (or is seeking), and particularly property insurances.

For example:

Construction costs
According to the Cordell Construction Cost Index, residential construction costs increased 2.9% for the 2023 calendar year, down from the 11.9% increase recorded in the 12 months to December 2022 – the highest annual growth rate outside of the introduction of the GST. Napier & Blakeley’s cost escalation forecast for the 2024 financial year is 5% to 7% for commercial construction – excepting Western Australia and Queensland, where it is tipping cost escalation to be in the order of 7% to 9%. Construction costs have a direct impact on the cost to repair or re-build a property.

Cost of building materials
The cost of materials continues to rise. Timber, board and joinery, as well as steel products, cement, copper, zinc, lead and other metals have risen the most. The Housing Industry Association (HIA) notes the cost of house building materials rose 4.4% in 2023, compared to 17.3% in 2021/22. This increase adds to the cost of repairs and building.

Availability of building materials
Many of the materials needed for building are hard to source. In particular, timber and steel are in short supply. This leads to cost increases and building delays.

Labour shortages
Low unemployment (3.9% in January 2024) has added to skilled and unskilled labour shortages. Within the building industry, the labour shortages are acute – the HIA Trades Availability Index indicates the industry is experiencing the most significant skills shortage in two decades. Labour shortages flows through to the costs to repair damaged property or rebuild.

Supply chain disruptions
Global and local disruptions to transport routes have impacted the availability of goods. Supply chain disruptions have made imported goods harder to obtain and seen delivery times blow out. Freight costs have also risen. For example, shipping containers cost four times as much as they did a few years ago. The result is higher prices for goods, so the replacement costs are higher.

Inflation
CPI in December 2023 was 4.1%, down from 7.8% in December 2022. In December 2023, one of the most significant contributors to the annual rise in the CPI was new dwellings. Increased fuel and utility costs also have a flow-on impact on the cost of goods and services. Global commodity prices are also being driven up by inflation. Rising inflation erodes the value of insurance covers.

Spate of natural disasters
Extreme weather events have exacerbated construction cost rises, by increasing demand for both materials and labour. These events add to repair and replacement costs, especially in affected areas.

Rising interest rates
The RBA has been lifting the official cash rate since May 2022, taking rates to the highest level in a decade. This impacts the cost of property financed, which flows through to the insured sums.

Limited availability of property/assets
For example, the price of new and used vehicles, and machinery, has increased dramatically due to short supply and long delivery times. Global shortages of raw materials needed to produce goods such as computer chips and furniture has also seen availability decline and prices increase. As a result, the replacement costs of many goods and assets are now considerably higher.

War in the Ukraine
The availability of commodities including metal and minerals, energy and fertilisers, have been affected by the Russian two-year long invasion of the Ukraine as production has been affected, along with disruptions to trade at ports. As a result, there is short supply and global prices have increased significantly. In addition, sanctions against Russia have impacted the pricing of commodities such as oil, gas and coal – driving up prices. Again, this can erode the value of sums insured.

Israel–Hamas war
International shipping has been impacted by the war in the Middle East. Transit through the Red Sea is fraught and shipping companies are diverting cargo. Increased shipping costs and delays adds to the cost of commodities, raw materials and goods.

Based on these factors, it is likely to cost significantly more to rebuild premises (e.g. shop, office, shed, home) or replace contents (home, business goods or stock-on-hand) after damage or total loss from an insured event.  

Calculating sums insured  

Tips to determine your sums insured are adequate: 

• For the most accurate re-building costs, engage a quantity surveyor or builder.
• Use a quantity surveyor to complete a valuation for higher value or bespoke assets to help determine the full replacement value.
• If using an online calculator, be mindful that all the cost variables are accounted for (see below).
• Base building sums on the cost of replacing the building structure itself, its fixtures (such as light fixtures, ceiling fans and central heating/cooling systems, built-in shelving units and cabinets, bathroom fittings like taps and showers, main plugs and sockets) and other features like sheds, decking, driveways and fencing.
• Do not base the building sum on its market value (what the property could sell for), rates valuation (the GRV your council uses to work out your rates) or the valuation provided by your bank (if the property is mortgaged), as these valuations are not based on replacement costs.
• Do not include the cost of the land, just the property/structures built upon it.
• Ensure the calculations are based on current building costs – prices for materials and labour have increased significantly.
• Make sure the calculations account for current building standards to be implemented – risk mitigation requirements, such as bushfire, cyclone or flood protections, can add substantially to re-build costs.
• Factor in structural improvements that have been made to the property, like sheds, decking and fencing.
• Include the cost of removing debris.
• Factor in the cost of engaging an architect and council fees.
• Include GST.
• Factor in inflation and exchange rates.
• Be sure to have cover for contents and stock, not just the building.
• Base contents replacement on a new-for-old basis.
• Do not use the original purchase prices to determine contents replacement costs.
• Do not base the sums on the value of assets in the balance sheet – these figures will factor in depreciation (written down value) and are not an accurate representation of the actual cost to replace them at the time of a loss.
• Be sure the sums are adequate to cover the number and value of assets, especially if contents have been added, replaced or upgraded with better quality and more expensive items.

Mid-term review 

Previously, it was generally accepted that an annual review (usually ahead of policy renewal) of sums insured would be adequate. In light of current economic conditions, more frequent reviews may be prudent for many businesses. 

Policyholders are urged to carefully consider their insurance requirements outside the “normal” 12-month cycle, with particular emphasis on property sums insured. 

To ensure that the insured amounts continue to adequately cover the value of your assets (home, business premises and stock), work with your EBM Account Manager to: 

• Identify the risks – from physical risks (flood, bushfire, crime rate) to financial and reputational risks. 
• Consider policy options including features, coverage, claim limits, excesses and premiums (some covers may no longer be available or cover the same risks or at the same levels, while some premiums may have risen significantly, due to prevailing market conditions). 
• Ensure you know and understand policy inclusions and exclusions (what the policy does and does not cover, and in what circumstances). 
• Engage a quantity surveyor to determine premises replacement costs. 
• Check sums insured and limits of liability reflect values and risks. 
• Discuss risk mitigation strategies including transferring risks to insurers. 
• For business owners, confirm you are meeting your requirements under cover i.e. contract terms and conditions (including disclosure). 
• Ensure your business inventory and valuations are up-to-date and reflect current costs. 
• Understand what is happening in the insurance marketplace. In general, the property market remains hard, so it is important to be aware of how insurers are operating. You may find there is no longer any “wriggle room” and your insurer won’t be able to help if you have nominated an inadequate sum insured etc.   
• Be sure to tell your EBM Account Manager about any changes in your circumstances that may impact your cover, as your insurer(s) must be advised or you could risk any payout being reduced, the claim denied, or the contract cancelled. 

Here to help 

We are here to help you secure the products you need with realistic sums insured based on current market conditions and a suitable contingency. Your EBM Account Manager has the expertise and resources to guide you through the assessment process and help you protect your assets from the risks you face. If you have any questions, please contact your EBM Account Manager on 1300 755 112.