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Declaring insurable values: Cost of under or over-insurance

Learn from Marsh Advisory’s Valuations consultants how inflation pressures can impact incorrect declared insurable values and lead to under or over-insurance
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by Simon O’Brien , 

Head of Valuations – Marsh Advisory

13/07/2022 · 5 mins 21 secs

Learn from Marsh Advisory’s Valuations consultants how inflation pressures can impact incorrect declared insurance values and lead to under or over-insurance.

At a glance:

  • Incorrect declared insurance values can lead to under or over-insurance.
  • Current inflationary pressures coupled with a hard insurance market present particular challenges and opportunities.
  • Incorrect declared insurance values can impact your claim settlement or result in inflated property insurance premiums.
  • Insurance policy terms may penalise insured businesses in the event the declared values are inaccurate.

As businesses emerge from the COVID-19 pandemic and attempt to shore up their cash and liquidity, many are faced with new risks ranging from events such as the recent historic floods in NSW & QLD, labour challenges, the spike in energy prices and supply chain disruptions exacerbated by the war in Ukraine. What’s more these risk factors are now compounded by surging inflation.

Surging inflation

In Australia, inflation is growing at its fastest pace in 20 years, the cost of living and increases in construction costs are front page news. According to data published by the Australian Bureau of Statistics (ABS) on 27 April, the annual inflation rate surged to 5.1% in Q1 2022 from 3.5% in Q4 2021, surpassing market estimates. And while OECD global forecasts predict the rate of inflation will fortunately moderate going into 2023, leaders in Australia are more cautious with new Federal Treasurer Jim Chalmers predicting at least a 5.1% rise by October 2022. In a rare interview on 15 June, Reserve Bank Governor Philip Lowe told the ABC that he expects the rate may go on to reach close to 7% by the end of the year and not fall until the first quarter of 2023.

Labour shortages

Labour shortages are also placing pressure on businesses. The National Skill Commission (NSC) reports that job vacancies have grown significantly beyond their pre-COVID-19 levels in Australia and New Zealand. The NSC’s most recent Skills Priority List found that 42% of technician and trade occupations are currently in shortage, compared to an overall 19% shortage across all assessed occupations.

The Construction industry has been particularly affected by ongoing shortages of materials and labour. New property remuneration research from Avdiev shows nearly 9 out of 10 building and construction companies are experiencing a skills shortage leading many to offer pay rises that are more than double the rate of inflation, just to retain the workers they currently have. This is contributing to the pressure for many construction companies resulting in the publicised collapse of several major companies.

Rising costs of insurance

The cost of insurance is rising across all geographies, and this consistent upward trend is mounting pressure on the bottom-line of businesses. According to Marsh’s latest Global Insurance Market Index, composite pricing in the Pacific region increased 10% in Q1 2022 and property insurance pricing increased 8%, mirroring the rate of increase in the fourth quarter of 2021. 

Guarding against under (or over) insurance

Businesses may seek to respond to the above pressures by relying on their existing insurance policies and previously determined declared values, only to realise that their assets are underinsured.

It is extremely rare that an insurance valuation reveals that the nominated declared values are correct to the exact dollar. This means that there is typically a variance between declared values and the true insurable value of assets.

This can be for a variety of reasons. Here are four examples: 

Declaring the values on an incorrect basis (i.e. market, book or written down value).

Relying on the indexation of old valuations that do not adequately capture the current market and inflationary factors

Declaring the value of only some insurable assets (i.e. focusing on buildings and ignoring the contents and equipment).

Not considering the current building codes.

Not taking into account elements such as removal of debris in the declared values.

Failing to nominate the correct sum insured can be disastrous in a loss event. It can severely impact your claim settlement and your ability to bounce back after a loss.

Are your insured values right?

Declaring accurate values is the insureds responsibility. While you may have received advice from builders, internal staff or those in the insurance industry, the ultimate responsibility to ensure they are adequate lies with the insured party.

An over-value can lead to paying more premium than you need to. On the other hand, an under-value can lead to an insufficient payout in the event of a claim.

In our experience, correctly valuing properties for insurance purposes requires a deep understanding of the underlying issues that affect the level of insurance cover your organisation needs. Engaging an expert insurance valuation team to help you declare the correct sum insured and sub-limits has never been more critical.

Double blow if a claim is pursued

In the midst of this hardening insurance market, Marsh is seeing more insurers re-introducing what’s known as a co-insurance or average clause for property insurance policies. Put simply, this is a clause within an insurance policy that can penalise the policy holder in a loss event when the declared values are inaccurate.

The potential effect of this clause is that, if a partial loss were to occur, which is by far the most common type of loss, and it was determined that the assets were not declared for the correct amount, the claim payable by the insurer may be reduced proportionally to the undervalued declaration.

For example, a building is currently insured for $10m and a loss occurs, the value of the damage is assessed and determined to be $5m. After the loss, the insurer determines that the total declared value for the location should have been $20m. In this example, the location has been under-declared by 50%. This could lead to the claim amount being reduced by the same proportion (50%) and see a settlement of only $2.5m, rather than the full loss amount of $5m.

Undertaking a valuation will assist your broker to negotiate the policy terms with your insurer and may mitigate the potential impact of a co-insurance or average clause.

The test of today

Given the unforeseen circumstances of the past two years, it is unsurprising to see volatility in the cost to replace assets; whether this is through impacts on labour due to widespread losses, increase in the cost of materials, delays in construction projects, ever-changing exchange rates, or rises in inflation.

This raises a valid question: How much is enough to replace an asset in the event that it needs to be rebuilt in today’s market?

Marsh’s dedicated Valuations team is available to you at any time to provide best-in-class answers, service, and solutions. For more information, contact your Marsh representative or a member of the Marsh Valuations consulting team. Contact us.

This publication is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Marsh shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. Any modelling, analytics, or projections are subject to inherent uncertainty, and any analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change. Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or re-insurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage. LCPA 22/300

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Simon  O’Brien

Head of Valuations – Marsh Advisory

“Marsh Pty Ltd (ABN 86 004 651 512, AFSL 238983) (“Marsh”) arrange this insurance and is not the insurer. The Discretionary Trust Arrangement is issued by the Trustee, JLT Group Services Pty Ltd (ABN 26 004 485 214, AFSL 417964) (“JGS”). JGS is part of the Marsh group of companies. Any advice in relation to the Discretionary Trust Arrangement is provided by JLT Risk Solutions Pty Ltd (ABN 69 009 098 864, AFSL 226827) which is a related entity of Marsh. The cover provided by the Discretionary Trust Arrangement is subject to the Trustee’s discretion and/or the relevant policy terms, conditions and exclusions. This website contains general information, does not take into account your individual objectives, financial situation or needs and may not suit your personal circumstances. For full details of the terms, conditions and limitations of the covers and before making any decision about whether to acquire a product, refer to the specific policy wordings and/or Product Disclosure Statements available from JLT Risk Solutions on request. Full information can be found in the JLT Risk Solutions Financial Services Guide.”