Essential steps for commercial property managers
Today’s business environment is ever-changing. Property owners face many risks that can jeopardise their investments and operational stability.1 These risks include:
- Skills shortages.
- The high cost of building materials.
- The necessity of meeting environmental, building regulation and planning standards.
As a result, reinstatement costs are on the rise.2
In the face of mounting financial pressures, some businesses might be tempted to reduce their commercial buildings insurance or commercial landlord insurance. However, this would leave them underinsured. Being underinsured can raise concerns for insurance providers, as it indicates a higher risk of financial loss. This may make it more challenging for the property owner to obtain affordable business insurance coverage in the future.
Beware of underinsurance
Research shows, 79% of commercial properties and 70% of residential properties are underinsured. On average, underinsured buildings are covered for just 63% of the amount they should be.3
If a property owner is found to be underinsured, they may be unable to cover certain costs. For example, costs of damages or injuries caused to others. If they can't cover these costs, they may face legal and liability issues.
This poses a significant risk. The average clause is a provision commonly found in insurance policies, particularly in property insurance. It is designed to ensure that policyholders insure their property for its full value. If a property is underinsured at the time of a loss, the average clause can affect the amount of compensation the policyholder receives.
How the average clause works
- Definition of underinsurance: Underinsurance occurs when the insured value of a property is less than its actual value. For example, if a property is worth £200,000 but is insured for only £150,000, it is considered underinsured.
- Calculation of the average clause: If a loss occurs and the property is found to be underinsured, the average clause will typically reduce the payout based on the ratio of the insured value to the actual value. The formula used is:
Claim Payment = Sums insured / actual value x the loss amount
Sum insured: The amount for which the property is insured.
Actual value: The market value or replacement cost of the property at the time of the loss.
Loss amount: The total amount of the loss incurred.
Example calculation
- Actual value of property: £200,000
- Sum insured: £150,000
- Loss amount: £50,000
Using the formula:
Claim payment = 150,000 / 200,000 x 50,000 = £37,500
In this example, the policyholder would only receive £37,500 instead of the full £50,000 loss due to being underinsured. The financial impact of this can be devastating. In turn, the need to self-fund the shortfall and potential delays in getting back to business as usual could threaten a business’s ability to continue.
To mitigate these risks, commercial property owners should:
- Review their buildings insurance policies.
- Ensure that the rebuild costs are accurate.
- Ensure that sums insured are accurate.
It’s the owner's responsibility to inform the insurer of the appropriate amount of coverage needed for their business premises.
There are several reasons why a business may be underinsured, including:
- Undervaluing buildings and physical assets when determining the sum insured. This can happen when using incorrect written down values, relying on outdated data, or not fully understanding the difference between market value and reinstatement costs.
- Failure to consider the cost of inflation when considering a rebuild cost.
- A belief that a major loss could never happen to them.
- Failure to review coverage.
- Reducing commercial property insurance coverage to save money. Failing to update coverage as the business grows or changes.
Avoiding underinsurance
To prevent your business from being underinsured you can take the following steps:
- Get advice from a professional broker.
- Conduct regular, accurate valuations of your business and property.
- Calculate and use your actual total revenue.
- Consider the time it would take to recover from a disaster.
- Regularly reviewing policy wording. Also adjusting coverage amounts as your business and external factors change.
Understanding and acknowledging the risks facing your properties is crucial. But it’s equally important to take action to address these risks. The Royal Institution of Chartered Surveyors (RICS) recommend a comprehensive property assessment every three years. But you should also consider factors like inflation or any renovations or improvements annually.4
We work with RebuildCostASSESSMENT to provide either:
- A desktop Rebuild Cost Assessment for just £150 + VAT.
- An onsite valuation service – price available on request.
Your business is your livelihood, and it’s essential to properly insure it against potential damage. In addition to reviewing your buildings insurance, consider:
- The impact of inflation on material costs.
- Skill shortages in the construction sector.
- Potential supply chain disruptions when determining your loss of rent indemnity period.
Being underinsured and experiencing longer-than-expected rebuilding times can have significant financial consequences.
Keep your insurance provider informed
Taking steps to reduce or manage risks can make your business more attractive to insurers. This potentially offers you more choices and more affordable coverage.
By addressing these key areas, commercial property owners can:
- Better manage risks.
- Present a more favourable profile to insurers.
- Protect their business's operational continuity and financial stability.
- Reduce legal expenses.
Find out how we can help you protect your property portfolio with business property insurance. Or contact your Marsh Commercial adviser.
Sources
1. britishchambers.org.uk/bcc-quarterly-economic-survey-firms-treading-water-on-investment
2. rics.org/building-reinstatement-cost-assessments
3. rebuildcostassessment.com/RCA-2024-infographic.pdf
4. rebuildcostassessment.com/reinstatement-cost-assessment-guide
