All real estate assets (with perhaps the exception of some government facilities) should be insured for reinstatement in the event of a fire or other disaster. The nature and extent of cover will vary around the world and across different insurance providers, but the fundamental principles are universal. Most insurance premiums are calculated based upon a percentage of the estimated value of cover being sought. This means that the level of cover requested will determine the amount to be paid in annual premiums. Therefore, ensuring the correct level of coverage is obtained not only provides adequate protection in the event of a claim, it also influences the expenditure associated with that insurance cover. Hence, cheaper premiums can often result in inadequate coverage, while higher premiums may provide protection in excess of what would be necessary (or potentially claimable).
The cost of real estate insurance premiums around the world are gradually rising, which means building owners can no longer afford to simply accept generic advice on insurance valuations. Being over insured can be as costly as having inadequate insurance and this latter situation is only discovered when claims are actually submitted.
Insurance companies, generally, provide limited guidance on whether the value proposed is adequate or more importantly sub-divided correctly. In certain parts of the world (for example UK, Australia, New Zealand, Malaysia, Singapore, and Hong Kong) the calculation of reinstatement valuations is a professional service provided by construction cost, building, or quantity surveying consultants. Elsewhere building owners rely on advice from accountants, real estate advisors, or insurance brokers.
As insurers try to mitigate their risks, the tendency to sub-divide insurance coverage into separate categories is becoming more common. This type of sub-division, separates the total insurance value into a number of categories, the most important ones, where professional guidance is necessary are listed below:
- Reinstatement Costs
- Fees and Charges
- Contents
The asset owner is usually required to allocate their desired total insured value across each of these headings or provide a specific value for each category. In the first approach, allocating the total desired insured value, the individual amounts stated then become the ceiling figure for any policy claim under that heading. This means that if US$100 were allocated against each heading the most the insurance company would pay out for any particular claim against that item would be US$100, irrespective of whether the assessed loss was US$200. This scenario comes a significant shock for may asset owners who mistakenly believe that they are permitted to claim up to US$300 (the total of all three headings) for any claim irrespective of the category under which the claim is being made [although it is recognised that some policies might permit this aggregation of value, the majority do not]. The result is that if the allocation across the different headings is not a realistic reflection of the cost impact likely to be suffered then asset owners have to cover the difference themselves.
In view of these issues and asset owner risks, the following provides practical guidance to assist in validating how the correct level of insurance cover should be calculated.
What is reinstatement?
First, it is important to understand what actually reinstatement of a real estate asset refers. Although exact policy wordings vary, the general principle is that only costs associated with the rebuilding of the damaged asset to the same specification and condition as before will be accepted. This means that any costs related to improvements or upgrades may be excluded and not covered by the insurance policy. The only exception (which needs to be specifically stated in the policy for the avoidance of doubt) would be necessary modifications because of changes in local code or to suit current statutory compliance. This particular aspect can be a very significant cost for older buildings.
Calculating Capital Reconstruction Cost
The capital reconstruction cost covers the replacement and reinstatement of the damaged aspects of the building. It is important to note that this amount should not be considered as being the current “market” value of the property (i.e. the resale price) nor should it be the cost that was paid for the initial construction (although this can serve as a guide). This amount should be the cost to reconstruct the asset at today’s prices. Typically, this construction cost should be validated each year to ensure the cost included tracks the local market price inflation.
Construction price books or published construction cost data can both provide useful sources of general information on this reconstruction cost. It is worth noting when calculating the reconstruction cost, that foundations are rarely replaced and basements often only require partial rectification. Hence, these values can be reduced or eliminated from the calculation.
In order to maintain adequate coverage, it is usually appropriate to include the complete reconstruction cost of the above ground asset, as the value for this category. This approach ensures there will always be adequate money to cover any partial reinstatement works involved, which are often more costly to perform than a complete building reconstruction.
Removal Costs
Sometimes the value of this category is grouped into the total capital cost, but it is important to determine a specific amount to cover this work. Key aspects to consider are:
- Removal of actual debris and rubbish from the site
- Removal damaged material which cannot be repaired and needs replacement
- Removal of plant or equipment which cannot be reused in the new building
- Decontamination of remaining structure
It is important to remember when making any claim, that in many cases the complete removal of the building will not be necessary, therefore determining the extent of removal will have to be specifically agreed with the insurers before the reconstruction work takes place. This means that it is often more expensive and time consuming to remove just parts of the structure than if the whole building were demolished. Insurers often insist on this partial removal because it will lower the capital reconstruction cost.
Fees and Charges
These are often-overlooked aspects of an insurance assessment, which again are often grouped into the capital reconstruction cost category, they include the professional fees, and other charges associated with the removal and reinstatement works. Examples of this category are:
- Designer Fees – associated with preparing new plans and drawings
- Supervision Fees – professional fees associated with supervising the reconstruction work
- Specialist Fees – fees associated with engaging environmental or decontamination experts or structural engineers to certify remaining structures
- Permit Fees – costs and charges relating to reconstruction activities as well final testing and certification, this may include the resubmission of building plans for statutory approval
- Legal Fees – fees related to the construction process only and not those associated with any claims or other issues (these are often a completely separate heading or policy and not addressed here)
- Sustainability Rating – most rating systems will require resubmission and recertification of the newly reconstructed asset
In all of the above aspects, the costs involved will be significantly lower than if this were a new building, because as-built design information should be available. However, where original construction information is missing or incomplete, consideration of the additional work involved should be made.
Contents and Fittings
Perhaps one of the most complicated aspects of any reinstatement insurance assessment relates to the contents of the asset. Whilst each tenant (in multi-tenant buildings) should provide their own contents insurance coverage, there would be some general aspects covered by the main insurance. Firstly, it is important to differentiate those aspects, which are part of the base construction (such as reception counters, toilets, plant and equipment, etc.) which should be covered by the capital reconstruction costs [clear definition of this aspect in the insurance policy is important] from those which are pure decoration (such as artwork). High value objects of art or features should typically be called out specifically in the insurance policy (since many policies have a limit on the value attached to individual items).
Where buildings are provided in a fully fitted out state (i.e. where the building is owner occupied) then again this definition must be clearly set out in the insurance policy with the costs allocated under the correct heading (contents, fittings, or capital reconstruction). Including the costs related to contents and fittings under the wrong heading will limit potential future recovery.
Conclusion
The above highlights many of the potential pitfalls, which may be encountered when preparing real estate reinstatement insurance assessments. Unfortunately, it is often not until a disaster occurs that the true implications of insurance preparation decisions is realised. In all cases, it is important to take the time and obtain professional assistance in establishing the insurance values. Equally, reviewing the assessment annually ensures values are kept up to date and appropriate for the local market conditions.
Ultimately, getting the level of insurance correct can reduce premiums (over insurance on major real estate assets can be expensive), but having the appropriate amounts available in the correct categories to permit the future reinstatement works to be carried out properly and timely is also vitally important.
Plateau Group 