Under Insurance Risk & the Co-Insurance Clause

Most buildings area covered by a Replacement with New insurance policy, which is the very best basis of settlement as it protects you with “new for old” coverage. To maximise the benefit of this coverage, it does mean you need to ensure that the declared building value or sum insured is adequate to fully replace the asset(s)in accordance with the current building code and with today’s ever-increasing building costs.

Are you familiar with the Co-Insurance Clause? [The penalty for being under insured]

A lot of people think that if they insure for $4,000,000 for example, they have no risk of having to contribute towards a loss until such time as the loss exceeds that $4,000,000. This is simply not correct.

The ‘Co-Insurance’ clause is found in most insurance policies and dictates that if you are under insured, only a proportion of the actual cost of repairing or replacing your asset will be paid by your insurer.

Here’s a simple example

Steven owns a six level office building and has insured it for $4,000,000. The property is damaged by fire with a damage bill of $3,000,000. The insurers determine that the actual replacement value of the building is $8,000,000. Steven is therefore under insured by 50%. Although Steven may think that the $4,000,000 cover he has is sufficient to cover the damage bill of $3,000,000, the application of the ‘Co-Insurance’ clause means that Steven is in fact an insurer himself for part of the risk. In other words he shares in the risk associated with under-insuring his building.

Lets examine how an insurer would assess payment for such a claim.

Insurers typically allow some tolerance for being under insured. This is often set at 20% - hence the calculation is based on 80% of the true value of the building at the start date of the Policy

So the basis for the calculation is as follows:

Adjusted Loss      =             Sum Insured or Declared Value X The amount of the Loss

                                                            80% of the value at Risk (replacement value)

The calculation for Steven’s loss is:

Sum Insured (Declared Value)                     $4,000,000 X $3,000,000 (the amount of the loss)

80% of the value at Risk (replacement value $8,000,000)                                  $6,400,000

                                                                                                         = $1,875,000

The Insurer pays $ 1,875,000 less any policy deductible/excess

Steven wears $ 1,125,000 plus any policy deductible/excess

It’s clear that although there was a buffer of $1,000,000 between the damage bill and the declared value. The insured is still out of pocket due to the application of the ‘co insurance’ clause because they failed to insure the building for its true replacement value. It may appear to be cheaper to under-insure to save a little in the annual insurance premium; however it is simply not worth it in the event of a claim.

We strongly recommend that a building insurance valuation is carried out every three years to reduce the substantial financial risk associated with under insurance by a qualified valuer with experience in building reinstatement valuations.

Ensure Group Property Valuers specialise in building valuations for insurance replacement purposes. Get in touch via the website, call on 9088 2032 or email valuations@ensuregroup.com.au