Between 2019 and 2024, the cost of rebuilding commercial properties in Australia saw a substantial increase. Data from CoreLogic indicates that the Cordell Construction Cost Index (CCCI) recorded an overall rise of 29.7% in building construction costs during this period. This surge can be attributed to inflation, rising material costs, and a shortage of skilled labour.
As we adapt to the reality of changing weather patterns, there is a growing recognition of the need for our properties to become more resilient to these conditions. Unfortunately, building resilience comes at an increased cost. Incorporating climate-resilient features, such as improved structural integrity, enhanced drainage systems, and sustainable materials, adds to the overall expense of rebuilding commercial properties.
Accurately determining the replacement value of your commercial property is essential for ensuring you have adequate insurance coverage and avoiding the enforcement of the underinsurance clause. Underinsurance can lead to significant financial shortfalls if your property suffers damage or loss, whereas overinsurance can result in higher premiums than necessary.
Understanding Underinsurance and Its Consequences
Underinsurance on commercial properties in Australia is not just a risk; it’s a potential financial disaster. When a property is underinsured, the insured amount is less than the actual replacement value of the property. This discrepancy means that in the event of a loss or damage, the insurance payout will not cover the full cost of rebuilding or repairing the property. Consequently, property owners may face substantial out-of-pocket expenses to make up the difference. This financial shortfall can jeopardise business operations, strain financial resources, and even lead to the loss of the property. Insurance policies often include an “average clause,” which is the main clause that reduces the payout in proportion to the underinsurance. Therefore, accurately calculating the replacement value and ensuring adequate insurance coverage is essential to avoid these potentially devastating consequences.
Example: A commercial property has a replacement value of $1,000,000 but is only insured for $800,000. An insurable event occurs (meaning the policy will respond to the loss) with a damage value of $400,000. In this instance, the insurer would apply the underinsurance clause and only be obligated to pay 80% of the loss ($320,000).
(Sum Insured / Replacement Value) x Loss Value
Calculating the Building Sum Insured
Property owners must accurately calculate the building sum insured to avoid underinsurance risk. Here are the key steps to consider:
- Determine the Replacement Value: The replacement value is the expense required to completely rebuild a property. This includes costs for demolition, design and architectural fees, labor, new materials, and other associated expenses. Factors such as location, building size, construction materials, and unique features are all taken into account.
- Assess the Building Structure: Take into consideration the specific elements of the building structure, including the type of construction, materials used, architectural features, and any upgrades or renovations that have been completed. The State Government and Local Council may mandate the inclusion of additional features in new buildings that the previous structure did not have. This could result in added costs, particularly if the property is located in a bushfire, cyclone, or flood zone. Additionally, wheelchair access may be required where it wasn’t previously.
- Include External Structures and Improvements: External structures and features must be included in the overall cost. These can encompass sheds, garages, fences, driveways, car parks, and landscaping.
- Consider Escalation and Inflation: Construction costs can rise over time due to inflation and market fluctuations. It’s essential to consider an escalation or inflation rate when calculating the sum insured. Insurers may apply the Consumer Price Index (CPI) adjustment upon renewal.
- Seek Professional Advice: Determining the building sum insured can be complex, and seeking professional advice is highly recommended. Online quoting tools can be helpful in estimating the replacement cost; however, the accuracy of these tools relies on the correct information being provided. Sometimes, it’s best to let the professionals handle it.
Avoiding Underinsurance: Practical Steps and Professional Guidance
Avoiding underinsurance involves more than just accurately calculating the replacement value. It requires ongoing attention to changes in the property, market conditions, and insurance policy terms. Here are some additional practical steps to ensure you maintain adequate coverage:
- Regular Reviews: Periodically review your insurance coverage to account for any changes in property value, renovations, or additions. Adjust your coverage as necessary to reflect these changes.
- Policy Updates: Stay informed about any updates or changes to your insurance policy that might affect your coverage. Insurance companies periodically update policy terms, and it is crucial to understand how these changes impact your coverage.
- Consultation with Insurance Brokers: Work with a knowledgeable commercial property insurance broker who can provide expert advice on the best coverage options and help navigate the complexities of insurance policies.
Properly insuring your commercial property against potential risks is crucial for financial security and peace of mind. By accurately calculating the building replacement value and understanding the risks of underinsurance, property owners can prevent significant financial shortfalls in the event of a loss. Seeking professional advice and regularly reviewing your insurance coverage helps maintain adequate protection and avoids the pitfalls of underinsurance. These proactive measures ensure your property is well-covered, safeguarding your investment and securing your financial future.
Reference:
CoreLogic Australia
https://www.corelogic.com.au/news-research/news/2024/construction-cost-growth-returns-to-trend
