Underinsurance: Recipe for Financial Disaster

Do not underestimate the importance of assessing the actual rebuild value of your property for insurance purposes and ensure that your home and/or business is as well protected as it should be. In the months leading up to June, with the uncertainty of the impending hurricane season, now is good time to make sure that […]

By Sanjay Amin

May 17, 2011

Underinsurance: Recipe for Financial Disaster

Do not underestimate the importance of assessing the actual rebuild value of your property for insurance purposes and ensure that your home and/or business is as well protected as it should be.

In the months leading up to June, with the uncertainty of the impending hurricane season, now is good time to make sure that your home or business premises are insured sufficiently, against not only hurricanes, but also against other perils such as earthquakes and fire.

It is true that Barbados has not had real hurricane for over 50 years and is in more sheltered position than its northern Caribbean neighbours in terms of the frequency with which serious storms strike. However, with the passing of Hurricane Tomas last year, we need to be reminded that Barbados is susceptible to extreme weather conditions.

On an even greater scale, the recent earthquake in Haiti not only resulted in tragic loss of life, but also caused untold damage to buildings, very few of which are likely to have been insured. In July 2009, BCQS International represented by myself went on voluntary mission to Haiti sponsored by the Royal Institution of Chartered Surveyors and found that the implementation of Building Codes was woefully lacking; not only were they insufficient, but there was very little evidence of the enforcement of any building codes at all. Unfortunately, the earthquake struck before any such codes could be put in place. There is, however, no question that robust and properly enforced building codes could have saved lot of lives, and kept people in their homes. Furthermore, proper insurance of these homes and buildings could have helped the rebuilding of Port-Au-Prince. Instead, Haiti is forced to rely upon international aid partly due to the pre-existing economic situation and partly due to the massive scale of the disaster.

Damage caused to individual buildings as result of earthquakes or hurricanes here in Barbados is unlikely to be the subject of such massive aid, and therefore owners here need to protect themselves and make sure that the full reinstatement cost of their building is reflected in their insurance policy. The failure to cover this full amount is known as underinsurance.

Underinsurance is when building is insured for lesser amount than the current rebuilding cost, this in turn means that the insurance premium paid is not representative of the actual risk, nor is it sufficiently contributing to the insurance premium pool used to help pay for losses. This may save building owner money in the short-term, in terms of the payment of lesser premium as percentage against an artificially low amount , but even the lesser amount that is paid may be wasted money should claim become necessary. Underinsured properties are subject to the insurance industry’s Condition of Average Clause which in essence, reduces the claim according to the percentage of underinsurance, relative to rebuilding costs.

To keep the maths simple, let’s say you decide to demonstrate an example, if building is insured for 50% of the rebuilding cost, the maximum of any claim made will be 50% of the insured amount, meaning that the owner will be unable to finance the rebuilding of their home or business premises. This is exacerbated by any deductable being taken from the 50% the owner receives.

As is often the case, owners do not necessarily know that they are underinsured until they make claim. This is usually because they are relying upon out of date information or are not getting the right advice regarding the value of their property.

In 2008 for example, the island of Grand Turk in the Turks and Caicos Islands suffered 85% damage to its buildings, the majority of which were either underinsured, or in many cases, not insured at all. This not only left people effectively homeless and left businesses without premises, but it also left people unable to service the very loans against which the enjoyment of their property or the income generated from it was relied upon to repay that debt.

The above example demonstrates why prudent funding institutions protect themselves by including clause within their terms and conditions that the reinstatement cost of the buildings against which they loan funds is assessed by qualified Appraiser or Surveyor, and that the resultant sum of that appraiser’s/Surveyor’s report is insured by reputable insurance company. The funder will generally also require that annual evidence of the coverage is demonstrated by the borrower throughout the life of the loan.

The best way to avoid underinsurance is to have property appraisal carried out every two to three years, and to insure for the rebuilding cost as appraised. In between appraisals, sums insured can be increased by an inflation factor which should form part of the property appraisal. Adjustments should also be made for any improvements made to the property.

The appraiser would calculate rebuild value based on current day construction cost to replace the building like for like. Such calculation requires full site inspection and measure of the size of the building. Experience of construction costs within the particular jurisdiction is fundamental, as well as experience of the vagaries of types of building use, and any structural or architectural nuances. The resultant sum would include not only the rebuild value, but an allowance for the demolition and removal of any remaining damaged structure, as well as an allowance for the professional fees required for the rebuild, such as the costs of appointing an Engineer, an Architect and Quantity Surveyor. Such valuations generally do not include any loose furniture or other unfixed contents.

As we have seen, the onus for insuring one’s property correctly is on the Owner, and not as one may suspect, on their insurance company, nor on their lending institution. As previously mentioned, diligent financier would demand that any loan against their security, (which is usually the subject of the loan itself, i.e. the property), is covered by adequate insurance for the full cost of reinstatement. However, in the event of an unleveraged property, it is often the choice of the individual owner, as to whether their property, and therefore their financial security remain at risk. We would recommend that the individual follow the lead of the Funding Institutions, and protect themselves with adequate insurance, rather than carry the risk of the possibility of financial loss in the future.

Sanjay Amin

Sanjay Amin FRICS ACIArb - Chartered Surveyor, BCQS International is a Fellow of the Royal Institution of Chartered Surveyors (RICS) and a director of BCQS International. He was educated in Kenya and the United Kingdom where he completed his secondary education at Durham School before undertaking a degree in Quantity Surveying at Newcastle Upon Tyne. Following graduation, he worked in London for Gardiner & Theobald, one of the largest firms of Chartered Quantity Surveyors in the world, gaining experience on a variety of commercial, retail and educational projects including offices, business parks, warehouses, industrial developments, shopping centres and leisure centres. After 12 years, he left Gardiner & Theobald in 1997 as an Associate Partner to open BCQS's office in the British Virgin Islands. In 2002, Sanjay and his fellow Directors decided to open an office in Barbados. In 2006, Sanjay moved to Barbados with his family to expand the company's operations. In January 2011 under Sanjay's guidance, BCQS opened an office in Trinidad. Sanjay's experience in the Caribbean includes managing a variety of commercial, residential, resort, airport, hospital and industrial projects in Barbados, Trinidad and the Eastern Caribbean. Further information on these projects can be found on www.bcqs.com. Sanjay Amin's other key qualifications and skills are listed below: Specialist in design and build projects in the United Kingdom. Specialist in whole life costing of materials in the United Kingdom (Life cycle costs). Member of the steering committee on concrete structures in the United Kingdom. Club Service Director of Rotary Club of Tortola (2004 - 2005). Member of the Rotary Club of Barbados (current). Assessor for membership into the RICS. Chairman of the RICS Caribbean Board (2010 - Current). Voluntary mission to Haiti on behalf of the RICS (2009). Current member of the RICS Americas Construction Council. Member of the RICS Global Governing Council (2013-2017).