HAS YOUR PORTFOLIO FALLEN INTO THIS TRAP?

The Managing Director of Buy To Let Group Partner Falcon Insurance, Pinder Dhaliwal highlights the worrying trap of property price inflation that no-one is talking about

[It] can even invalidate your insurance policy, meaning that you will not be covered at all if something goes wrong.

Recently, at Falcon Insurance, we had a new client come to us who was in the process of purchasing a two-bedroom stone-built mid-terrace in the North for £65,000. When we asked her to get a reinstatement value (the cost to rebuild the property from scratch) estimate it came back at £187,000. Had the purchase price been used as the guide, it would have been almost two-thirds underinsured. There are two issues here. Firstly, many property owners associate the market value to be the value they need to insure their building for, which unfortunately isn’t the case. And secondly, as market values have risen amid a backdrop of soaring building and material costs reinstatement values have almost certainly increased too. This is just one example, but underinsurance is a worrying trend we are seeing emerge with investors who have not revalued their property within the last five years.

WHAT IS UNDERINSURANCE?

Underinsurance is when an individual or business has insurance coverage that is insufficient to cover the full extent of their losses – in the case of property, the rebuild or reinstatement costs in the event of fire destruction or another catastrophic event. Underinsurance can occur when an individual purchases a policy with too low limits, fails to update their policy as their needs change or makes a claim for damages that exceed their policy limit. It can also occur when a business purchases a policy that does not cover all of its potential risks.

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HOW DOES IT HAPPEN?

Underinsurance can happen for a number of reasons. It may be that the insured doesn’t

fully understand their coverage or that they’re not aware of all the potential risks they face. In some cases, people may intentionally under insure in order to save money on premiums. However, this can be a risky strategy, as it may leave the policyholder with inadequate coverage if they need to make a claim. Underinsurance can also occur when a policy is not properly updated to reflect changes in the insured’s circumstances or keep pace with inflation as we are currently seeing in the property market.

WHAT IS THE ‘AVERAGE CLAUSE’?

The ‘average clause’ is often added to insurance and can be found in the small print. It is a way of insurers paying out less than they need to if a policyholder is paying less than the premium they should be because they have inadequate cover. Insurers apply the average clause and only pay out a proportionate amount for what you are claiming based on how much you are underinsured by. The average clause is there to ensure that policyholders declare the proper value of their goods and so pay the correct premiums.

WHAT’S THE ISSUE?

Underinsurance can have a number of consequences. If you are underinsured, you may not be able to make a claim for all of the damage that has been done to your property. This could leave you with a repair bill.

Underinsurance can even invalidate your insurance policy, meaning that you will not be covered at all if something goes wrong. This could leave you facing financial ruin if you need to make a claim. Your insurer may apply the average clause to your claim meaning the payout could be considerably less than your claim.

Here is an example.

If you value and insure your property at £300,000, but the true cost to rebuild it is £600,000 then you would be effectively underinsured by 50%. So, if you made a claim for damage say for £100,000 your insurer would only pay out half of your claim so £50,000 then, minus your policy excess, potentially leaving you seriously out of pocket. It is recommended that you review the cost of the rebuild of your property every year to ensure the value it is insured for has kept pace with inflation. If your insurer believes that you underinsured your property on purpose to reduce the cost of your premium then it can refuse to pay out at all and can cancel your policy altogether. Underinsurance can happen to any insurance policy, whether it's property, buildings, contents, business or vehicle insurance, so it’s important to make sure you fully understand the value of what you are insuring.

GET COVERED

For residential properties you can use the ABI Rebuild Cost Calculator to work out the cost to rebuild your property. Falcon Insurance also offer a Rebuild Valuation Service assessment service available for both residential and commercial customers which works out the costs for you ensuring you get the correct insurance.

Visit www.falconinsurance.co.uk for more info