This month Paul Robertson kindly reproduces some extracts from his book looking at who is responsible for setting the sum insured and the impact of the dreaded average clause in the event of underinsurance.
The theme this month is valuations and I have chosen to reproduce a few edited extracts from my book – Robertson’s Insurance Principles for Leasehold Flats that may be of interest.
In chapter five I comment: The responsibility for setting a correct sum insured for buildings insurance rests firmly on the policyholder – ironically the very party who, in most cases, has the least understanding of the matter.
In reality very few people actually have a comprehensive understanding of the subject and as a result many blocks are insured for the wrong amount. All too frequently, this leaves flat owners paying the wrong premium, being exposed to possible failure of their policy and insurers not collecting the appropriate premium for the risk.
But what is the consequence of being underinsured. This extract from chapter seven may help you understand the consequences:
The Average Clause
We have already established that the duty to ascertain the correct sum insured remains firmly the responsibility of the policyholder. You may be thinking at this stage that this is somewhat short sighted of insurance companies; surely if a high proportion of blocks are underinsured then insurers are not receiving the full premium they would be charging if the block was insured for the total reinstatement figure? Well think again. It is time to introduce one of the insurance industry’s most feared wordings – the average clause.
This dreaded clause, sometimes referred to as ‘the application of average’ is quite simple to understand. As a policyholder who is underinsured, you will only have paid the insurer part of the premium they would have charged if you were fully insured. In recognition of this the insurer will only pay part of the claim. A simple version of a typical wording may look like this:
Where a sum insured is stated to be subject to average, this means that if at the time of damage, the sum insured is less than the total value of the property insured, you will
(a) be responsible for the difference
(b) bear a proportionate share of the loss
So let’s imagine a situation where you have insured a building for £1,000,000 which should have been insured for £2,000,000 and you submit a claim for £100,000. The maths would look like this:
Buildings insurance sum insured £ 1,000,000
Actual cost of reinstatement £ 2,000,000
Amount of claim £ 100,000
(excluding application of average)
Application of average 50% (£ 50,000)
Payment from insurer £ 50,000
So effectively the insurer is saying that as you have only paid half the premium they will only pay half your claim.
The impact of average on total loss
It is worth also considering how this might look if you consider a total loss situation where the maths would look as follows:
Buildings insurance sum insured £ 1,000,000
Actual cost of reinstatement £ 2,000,000
Amount of claim £ 2,000,000
(excluding application of average)
Application of average 50% (£1,000,000)
Payment from insurer £ 1,000,000
If we imagine this is a block of 16 flats, that’s a shortfall of £62,500 per flat, which is a fairly significant failure of the block of flats insurance.
Top Tip
If you find a sum insured or declared value that has a lot of zeros then almost inevitably it has not been index linked. This may be fine if it has recently had a rebuild cost assessment but, more often than not, it is simply because the insurance provider is not index linking the sum insured. You can quickly verify this by checking the sum insured for the previous year.
If you want to understand the subject better then you may wish to consider reading my book – Robertson’s insurance principles for leasehold flats. It is now in print and available to order at www.1stsureflats.com/book-release
Paul Robertson, Managing Director
1st Sure Flats and Midway Insurance / Email: [email protected] / Tel: 0345 370 2848 / www.1stsureflats.com.
