If your landlord clients are looking at taking out or renewing a policy that includes building cover, it is important that they keep their eye on the sum insured.
A building sum insured is the figure that the policyholder nominates to cover the cost of reinstating the property after damage from an insured event.
The sum nominated is the estimated amount that it would cost to return the property to the same state prior to the damage occurring.
The sum needs to factor in all the costs of repairing and/or replacing the damaged or destroyed property.
As the sum insured is usually the maximum amount that an insurer will pay out in the event of a valid claim, it is important that it is accurate.
If the landlord underestimates the cost to replace the property, they can find themselves underinsured and facing the prospect of not having enough money from the payout to reinstate the rental.
If the landlord overestimates the cost of replacement, they can end up paying a higher premium than necessary. It should be noted that an insurer will usually only pay out the actual cost of a loss.
So, if the property is over-insured, the policyholder will not receive more than their claim was actually valued at, meaning they would have paid a higher premium for no added benefit.
How building sums insured are calculated
The building sum insured should be based on the cost of replacing the building structure itself, as well as its fixtures (such as light fixtures, built-in wardrobes, ceiling fans, central heating/cooling systems, built-in shelving units and cabinets, and bathroom fittings, like taps and showers) and other features (such as sheds, decking, driveways, pools and fencing).
It should not include the value of the land the property sits on.
The figure needs to be based on current building costs and allow for current building standards to be implemented including risk mitigation requirements (e.g. bushfire, flood or cyclone proofing).
The calculation also needs to include the cost of demolition and removing debris, plus architect costs and council fees, any government charges and taxes (including GST).
To obtain the most accurate rebuilding cost, you can suggest your landlords engage the services of a quantity surveyor.
If they don’t want the expense, you could also point them in the direction of online calculators such as those on the Insurance Council of Australia website.
Why building sums insured need to increase each year
Landlords need to periodically review the nominated building sums insured to make sure they remain adequate for their needs.
The sums would obviously need to be adjusted if improvements are made to the property to ensure that the new replacement costs are captured.
What isn’t so obvious, is that the sums need to be reviewed on account of two key factors – inflation and escalation (rising costs).
The reason is simple. Inflation erodes the value of the sums insured. As the cost of goods and services increases over time, if the sums insured aren’t increased in line, the value diminishes.
In recent years, the rate of inflation (CPI) has been high.
For example, the annual 2022 CPI movement of 7.8 per cent was the highest since 1990.
Even though the rate has slowly been coming down, it is still impacting the cost of housing.
Although the CPI rose 3.6 per cent over the 12 months to the March 2024 quarter, housing inflation was 4.9 per cent, according to ABS figures.
Costs have risen
When it comes to building, costs have also surged.
According to CoreLogic’s Cordell Construction Cost Index, construction costs rose 11.9 per cent over the 2022 calendar year – the largest annual increase on record (excluding the period impacted by the introduction of the GST).
It has taken more than a year for the rate of increase to finally begin to ease, with FY24 seeing construction costs rising 2.6 per cent.
Building material prices have also skyrocketed in the last couple of years.
For example, in 2022, the cost of steel products, including beams and sections and reinforcing steel, rose 42.1 per cent, while timber, board and joinery, including windows and doors, increased 20.6 per cent. Today, material prices are beginning to stabilise but still contribute to rising construction costs.
In addition to the cost of building materials rising, labour costs are also rising.
According to the Housing Industry Association, there is a severe shortage of tradies, pushing up labour costs.
It follows that if the cost of materials and labour is rising, then the cost to reinstate property will also be higher.
To reduce the impact of inflation and the effects of escalation eroding the value of sums insured, the figures need to be adjusted each year.
Landlords should review their sums insured to check the nominated figures are adequate.
Many insurance providers, including EBM RentCover, index the building sums insured to reflect increasing costs.
This means the insurer automatically increases the sum insured by a fixed percentage on renewal.
While this provides some additional protection against inflation, it may not be enough to cover the real increased cost and the impact on the sum insured.
Review regularly
You might like to encourage your landlords to properly review their sums insured come renewal – with costs continuing to increase, it could be easy for landlords to find themselves inadvertently under-insured.
Not to avoid the elephant in the room… but the simple fact is, an increase in the value of the building sum insured is likely to result in a higher premium being charged. It is not welcome news, but it needs to be considered in the context of risking under-insurance.
Deliberately under-insuring a property can prove a false economy, one borne out in the event that the landlord needs to make a claim and their payout falls woefully short.
While small rises in the cost of goods and services may appear insignificant, they can soon add up and result in a greatly diminished value in the sum insured.
You might be surprised to hear that recent estimates put the cost of a new build at 40 per cent higher post-COVID, compared with building pre-COVID.
Now, if a landlord had not increased the building sum insured since 2020… well, you get the point.
Having less money available to reinstate a rental after an insured event could prove financially devastating – threatening both your landlord’s and your income.
In the grand scheme of things, making sure the building sum insured is adequate is prudent.
If you have questions about sums insured, please get in touch with your EBM RentCover Relationship Manager.
Or, not already partnered with EBM RentCover? Contact us today.
