In this article, the first in a new series on property, we explore the issue of ‘under insurance’ and the need to ensure you have an accurate reinstatement value on your property.
A common problem for property owners making insurance claims after Hurricane Ivan has been the issue of ‘under insurance’. As most people are now aware, this occurs when the sum insured is considered by the insurance company to be less than the reinstatement value of the building covered.
In this regard, the insurance company will view the claimant as having self insured part of the building and thus will only pay out on the percentage of the claim that the insurance company considers it has insured.
This is known as the principle of ‘average’. For example, if a person has insured their house for $100,000, but the reinstatement value of the house is actually $200,000 then the householder will be considered to be self insuring 50 per cent of the building. Thus, if the owner has a $90,000 claim for damage only 50 per cent of the claim will be covered and a payment of only $45,000 will be made by the insurance company.
Most of the confusion in this regard has arisen through the misunderstanding by property owners of what the reinstatement value actually is and how it is arrived at.
The reinstatement value of a property is not the same as the market value. Market value is defined by The Royal Institution of Chartered Surveyors as ‘the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.’ This definition importantly takes into account the value of land upon which the building is constructed, also such other factors as the age and condition of the building, its location and desirability in the market.
The reinstatement value takes none of these factors into account and is concerned with the actual cost to reconstruct the insured building, as of the valuation date. The cost to construct will have no regard to the age or state of repair of the building being valued but will take into account the type of construction, such as whether concrete block or timber framed, the quality of fixtures and fittings and general standard of finish. In addition to the actual cost of construction, the reinstatement valuation should also include an allowance for the removal of debris based on the assumption that there has been a total loss of the building being valued and that the site requires clearing in order for reinstatement to take place.
A sum to cover any necessary professional fees that would be incurred in the reconstruction of the building being valued, should also be included such as architects, chartered surveyors and consulting engineers. A further inclusion should also be made for any necessary planning or environmental impact fees that would be required.
Without any centralised database of building costs in the Cayman Islands, such as the Building Cost Information Service of The Royal Institution of Chartered Surveyors, available for the United Kingdom, it is essential that the reinstatement valuation is prepared by a qualified Chartered Surveyor, who will rely on their own experience and knowledge to ensure the accuracy of the valuation.
Even if a professional reinstatement valuation has been prepared by a Chartered Surveyor, the issue of under insurance can still be raised by an insurance company if the valuation is not considered to be current. How frequently a property should be revalued for insurance purposes is debatable, however regard should be had to the construction market and the general economy as a whole. Times of high inflation, when labour costs and the price of construction materials may increase quickly, would require a greater frequency of valuations than times of economic stability. The Consumer Price Index for Housing can be a useful indicator of this, however it should be noted that this index also takes into account such factors as house rents and even insurance costs, as well as the cost of construction materials. Therefore, for example, in times of rapidly increasing rents and insurance premiums, such as the current market, an increase in the CPI for Housing may not necessarily indicate a corresponding increase in construction costs. As a rule, a prudent property owner would be advised to ensure that a reinstatement valuation is prepared on his property at least once every three years.
The issue of reinstatement valuations is of particular importance to the Executive Committees of Strata’s who are required by law in the Cayman Islands, under the provisions of the Strata Titles Registration Law, to ensure that the replacement or reinstatement value of the strata property is adequate.
They have a duty to ensure that not only has a professional reinstatement valuation been prepared but that it is also considered to be current. Failure to do so may result in the board members being found personally liable.
Simon Watson is General Manager of Deloitte Property Consulting Services. He is a Fellow of The Royal Institution of Chartered Surveyors with 20 years experience in property valuations, half of that experience gained in the Cayman Islands. Deloitte Property Consulting Services provide a comprehensive range of services including project and construction management, contract and financial monitoring of projects, valuations and appraisals, quantity surveying, property management and insurance claims adjusting services.