As the world changes, insurance is generally very good at responding to new emerging risks
Cover for the latest cyber and social engineering risks are now readily available and with what we are told is an inevitable switch to driverless cars, policies will no doubt adapt as changes are required.
However, in other areas insurance can be archaic and hasn’t moved on. In fairness, the recent Insurance Act has modernised the law relating to the disclosure of information to insurers (although that took over 100 years), but little has been done regarding possibly the biggest issue facing insurance and also stems from the early 1900s; underinsurance.
Anecdotal evidence suggests up to 80% of buildings could be underinsured and one of the main reasons is that setting sums insured is so complicated, especially with older buildings.
Prior to the First World War, insurance claims were settled following the principle of indemnity (putting you back in the same financial position as you were before the loss), meaning a deduction was made for wear and tear. If a property was rebuilt ‘as new’, the claimant would make a contribution for ‘betterment’.
However, after the First World War, reinstatement cover (more commonly known as new for old) was introduced because of rapidly rising prices. Back then a normal indemnity policy was issued with the option of a ‘top up’ policy for the difference between the indemnity value and the cost of replacing with new equipment.
At the time it was a temporary arrangement, as there were misgivings that a profit (in the form of the betterment) could be made from insurance claims, but nowadays reinstatement is the norm for commercial property policies, with acceptance that many policyholders are not in a position to afford or fund the betterment, should a major claim occur.
The reinstatement wording was ‘modernised’ before the Second World War and updated again in the 1980’s to include the ‘Day One’ inflation provision (to cater for the high inflation at the time), but has otherwise remained largely the same.
Since the introduction of reinstatement, there has been a significant change in building design and construction methods, particularly with steel frame buildings and the main problem is that most claims involve partial, not total losses. That means buildings generally have to be repaired or restored, rather than rebuilt, usually at a much higher cost.
I frequently hear “I wouldn’t build it like this again” and as many property owners assess their sums insured on the cost of a modern rebuild, they are often underinsured. However, the sum insured needs to be sufficient to reinstate in the current form to cater for partial losses, even if the cost of reinstating an older building exceeds the market value.
In the case of listed buildings or those in conservation areas, buildings cannot just be replaced in a modern form, but others can and insurers have tried to help with the ‘Obsolete Buildings Clause’. They agree a discount on the basis that a building would be rebuilt in a modern form, however, partial losses are still a problem and the cost of reinstating in the existing form still generally needs to be assessed.
It is also worth noting that if plans are in place to demolish and redevelop a site, it is not generally worth insuring the building. Your insurable interest in a property is dependent on a financial interest and if there is no value, there is no claim. In these circumstances, extra demolition and debris removal costs can be covered, as these are likely to increase if a serious fire occurs, as compared with an organised demolition.
The insurance industry will hopefully find a solution, but in the meantime the best answer is to have buildings professionally valued for rebuilding purposes. This comes at a cost, but as property is often your main asset, it is worth getting the insurance right.