Many Residents’ Management Companies (RMCs) unknowingly leave themselves exposed to serious financial and legal risks through a common pitfall: underinsurance.
Underinsurance may not seem like an urgent concern – until something goes wrong. If your building suffers a major incident such as a fire, flood or structural failure, inadequate insurance cover can lead to significant shortfalls and legal redress. The consequences can be devastating for everyone involved, with leaseholders left to foot the bill.
So, what exactly is underinsurance, why is it so common, and what can RMC directors do to avoid it?
Understanding Underinsurance
Underinsurance occurs when the “sum insured” on your buildings insurance policy is less than the actual cost required to fully reinstate the property after a total loss.
This reinstatement cost should reflect not just the materials and labour needed to rebuild the structure, but also associated costs such as demolition, debris clearance, professional fees and compliance with modern building regulations.
It is important to understand that this figure is not the same as the property’s market value, which relates to its saleability.
If your building is underinsured, insurers are likely to apply the “average clause” to any claim. This means that even partial claims could be significantly reduced in proportion to the level of underinsurance.
For example, if your block is insured for £2 million but would actually cost £2.5 million to rebuild, only 80% of the claim is likely to be paid, leaving a substantial shortfall to be covered by leaseholders.
How Underinsurance Happens
One of the most common causes of underinsurance is relying on outdated reinstatement cost assessments (RCAs). Building costs are constantly evolving, especially in times of economic volatility. Labour shortages, increased material prices, and rising energy costs have all driven up the price of construction in recent years. An RCA that was accurate three or four years ago may now significantly underestimate the current rebuild cost.
Another key factor is building improvements. Renovations such as loft conversions, roof replacements, extensions, or re-cladding works can all increase the rebuild value of a property. If the insurance policy is not updated following these changes, the building could quickly become underinsured.
We are also seeing a growing reliance on desktop valuations (assessments based on online data rather than a physical site visit). While these can be useful for interim reviews or standard properties, they may miss crucial details that affect reinstatement value. The building’s condition, unusual construction features, or alterations may not be visible in public records – these will only be noted by an in-person assessor.
Lastly, there is a common misconception that market value is a suitable proxy for rebuild value. In reality, the cost to rebuild a property from scratch often far exceeds its market value – especially when demolition, site preparation, and compliance costs are considered.
The Impact on RMCs and Leaseholders
The consequences of underinsurance go beyond reduced payouts. For RMC directors, there are legal responsibilities to consider.
Most leases will include clauses requiring the property to be insured for its full reinstatement value. Failing to meet this obligation can lead to disputes, legal action, and even potential personal liability for directors who are found to have acted negligently.
From a financial standpoint, if a claim is underpaid due to underinsurance, the RMC may need to raise the shortfall via leaseholder contributions. This can place an unexpected financial burden on residents and cause significant unrest within the block.
In some cases, mortgage providers may also raise concerns about the adequacy of insurance, especially if the issue is raised during valuation or refinancing processes.
How to Stay Protected
Fortunately, underinsurance is avoidable with the right practices. The most effective step an RMC can take is to commission a full, onsite reinstatement cost assessment every three to five years, or more frequently during periods of high inflation. These assessments should be carried out by a qualified surveyor with experience in residential blocks.
It is also essential to review your building’s insurance cover whenever major works are carried out. This could include anything from internal reconfigurations to external cladding changes, all of which can alter the cost of a full rebuild. Simply renewing the same insurance figure year after year can cause big problems in the event of a claim.
Maintaining organised documentation is also important. Keep records of past RCAs, any major building works, and your most recent insurance policies. These will serve as evidence of your due diligence and support your position in the event of a claim.
Finally, clear communication with leaseholders helps build understanding and support. Explaining why an updated valuation is necessary and how it protects everyone’s financial interests can smooth the path when decisions about budgets or professional surveys arise.
Final Thoughts
Underinsurance is a silent risk, often hidden until a claim is made and when it’s too late to fix. For RMCs, staying on top of reinstatement valuations is not just a best practice, it is a fundamental responsibility.
By taking a proactive approach, commissioning regular, on-site, professional assessments, and responding promptly to building changes, RMCs can protect their buildings, their leaseholders, and their own reputation.
Insurance should be a safety net, not a gamble. Make sure your policy is built on solid foundations, not outdated assumptions.
