The rising cost of construction: making your clients aware of the impact on their insurance

10 March 2022

Now, more than ever, it is important to set and maintain sums insured at the correct level if you are to avoid the risk of underinsurance. Building costs are increasing at a high rate.

A beautiful heritage building covered in scaffolding

A number of factors have come together, not least the global pandemic. After an initial delay, the construction industry continued to build during the first lockdown, with suitable, and potentially costly provisions made for working in a Covid-secure manner, which led to increased demand for building materials.  

This, combined with the lengthy delays associated with production of materials, including from overseas, has led to demand outstripping supplies with a resultant increase in costs. Add to this the issues arising from Brexit; trade deals under negotiation, the loss of European workers and drivers etc, and a falling exchange rate. Other external influences have come into play, such as the increase in fuel costs and the grounding of the Ever Given container ship in the Suez canal for six days, putting further strain on an already stretched supply chain. 

Examples of the rising cost of materials

Some items are showing staggering increases in cost, steelwork costs have shot up by nearly 50%1 over the last 12 months, all things timber are showing an increase in excess of 30%* year on year, both items being used extensively in UK construction.  In all, this has led to building cost inflation running at around 10-12%.
And it’s not just buildings. The Retail Price Index and Wholesale Price Index, collated by the Office for National Statistics, are both showing increases of about 11% and 9% respectively, so this should be borne in mind when setting contents and stock sums insured.

How rising costs can put clients at risk

It is reported that a significant number of properties are underinsured. This means that in the event of a claim, the policyholder faces the possibility of having to fund some of the repairs themselves.  This may not have any particularly detrimental effect on the organisation if the claim is small, but if it runs into tens of thousands of pounds, this may hit the policyholder hard.  So it is vitally important to set the correct sums insured. 
Underinsurance is often unintentional, people simply don’t know how much it would cost to put the building back in the event of a catastrophic fire.  It might also be the case that the sum insured is deliberately set low, to reduce premiums.  Not only could this be considered deliberate misrepresentation, which in itself could result in the policy being voided, but any claim is likely to be reduced.  As an example, say the cost to rebuild a property is £500,000 but the sum insured is set at £250,000 or 50% of the value at risk. Any claim would be settled at half of its value, which could run to £250,000 if this property was completely destroyed, impacting the potential for the business to recover. This is known as the application of Average.
There can be many reasons for a building to be underinsured. A common misconception is that the market value of the property is a suitable level of cover. The market value is determined by many factors but is ultimately the amount that a buyer is willing to pay for it.  What is needed is the cost to rebuild in the same manner, including debris removal, outbuildings, walls, fences, hardstanding etc and making suitable allowance for professional fees that might be involved in any rebuild. The policy also covers any works required in order to comply with current Building Regulations.
Failure to make allowance for extensions or significant refurbishments, additional costs associated with debris removal or difficult access, the inclusion (or otherwise) of VAT can all add to the problem.  

Support from our risk specialists

Expert advice should be obtained and the figures regularly reviewed. For qualifying customers, Ecclesiastical’s team of in-house Risk Management Surveyors and Appraisers can provide a valuation without any additional charge. Provided the policyholder follows our advice and lets us know about any changes to the premises, we can remove any underinsurance (Average) clause, leaving them free of any chance that a claim would be reduced.
Once an accurate sum insured is set, it is important that this is reviewed and kept up to date by a suitable mechanism, which takes the (construction) market conditions and inflation into account. An insurance policy is usually index-linked or protected against inflation by a general uplift. In addition to the commonly available indices provided by the Building Cost Information Service (BCIS), Ecclesiastical has partnered with BCIS to build an exclusive index (the Ecclesiastical Heritage Index) to keep the sums insured for historic buildings up to date.  It should be noted that no index can be guaranteed to keep figures up to date indefinitely, so it is important to revisit the rebuild cost at least every five years. 
Underinsurance is not only applicable to buildings, but also to contents, stock and Business Interruption insurances too.  Taking information from annual accounts will lead to incorrect figures, so it is important to be aware of the basis on which the sum insured should be calculated.

Underinsurance case study

An organisation had insured their buildings for £410,000. They suffered some damage which cost in the region of £48,000 to repair. Unfortunately, the sum insured was insufficient so the claim could not be met in full. They had set the sum over 15 years ago when they purchased the building and hadn’t reviewed the figures since then, nor could they find any record of how the original figure was arrived at. A more realistic sum insured for the building was £1,225,000, so the claim was reduced, leaving them having to find roughly £31,000.

Want to know more?

If you have questions please speak to your usual Ecclesiastical contact.