Read an interactive and user-friendly version of this guide below.
The purpose of insurance is to reduce financial uncertainty by providing peace of mind that, in the event of any financial loss, you are covered and won’t be left out of pocket.
So long as your property is insured for its rebuild value, the cost of repairing or rebuilding your home is taken care of if something unexpected happens. But what happens if your property is not insured to its full, current rebuild value?
At Total Landlord Insurance, we have seen a significant increase in landlords whose rental properties are underinsured, putting them at risk of serious financial loss. In this guide, we’ll explain all you need to know about underinsurance, why it is a particular problem at the moment, and what you can do to avoid it. But first, what is ‘underinsurance’?
Underinsurance is a term used to describe a situation where the insurance coverage is insufficient to cover the actual cost of repairing damage or making up for loss if there is an unforeseen event, such as fire or a natural disaster. If you insure your property for less than its rebuild value, you could be left in financial turmoil in the event of a fire, flood or other serious loss. This is because the property would be ‘underinsured’, and if you needed to make a claim insurers would not pay out the full amount.
As a landlord, it’s your responsibility to calculate and declare the rebuild cost of your rental property and make sure that it’s insured for the correct amount, as this is the maximum amount your insurer will pay out if you need to make a claim.
“The most important thing when it comes to insuring your property, is that the premium is based on the rebuild cost, not what you paid for the property or the current market value. If you have a claim for £25,000 and the loss assessor judges that you are actually underinsured by 50%, the insurance company would only pay 50% of the claim, so you would only get £12,500 back, which would mean you’d need to deal with the shortfall out of your own pocket. On a smaller claim you may be able to get around it, but on a bigger claim, you may find yourself in a position where you would be unable to afford to get your property rebuilt.”
Steve Barnes, Head of Broking at Total Landlord Insurance
Landlords who underinsure their properties could potentially lose out on thousands of pounds worth of claims that might have been avoided. How would you cope if you needed to find £25,000 for a £50,000 claim?
How common is underinsurance?
The risk of underinsurance increases when the economy is under pressure. And as costs have been going up across the board, the underinsurance gap between property rebuild costs and the amount buildings are currently insured for in the UK, is widening.
According to the latest figures from RebuildCostASSESSMENT.com – the insurance industry’s most reliable benchmark for property sums insured – around nine out of every 10 properties in the UK are insured for the wrong amount. On average, underinsured properties were covered for just 66% of what they should have been in the period September 2021 to August 2022, compared to 68% the previous year, showing how the buildings underinsurance gap is widening in the UK.
The underinsurance gap is biggest among buildings insured for up to £500,000, which are on average only covered for 51% of their rebuild cost.
Buildings insured for more than £2 million are less underinsured, but are still covered on average for only 70% of reliable rebuild cost. And when it comes to UK commercial properties, the estimated underinsurance total is an eyewatering £375 billion.
This level of underinsurance means that, in the event of a claim being made for serious damage, the amount paid out is often significantly less than the property is actually worth.
There are also instances of overinsurance too but they are less common –13% of buildings assessed were covered for too much, on average by 132%.
Commenting on the findings, RebuildCostASSESSMENT.com director, Will Molland said: “Given the huge rise in the cost of buildings materials, as well as associated costs such as professional fees, it isn’t really surprising that the underinsurance gap is widening.
“These figures do paint a worrying picture for many property owners, who are exposed to a significant shortfall in claims payments should they suffer a loss. Let’s be clear, UK buildings are on average covered for just two thirds of what they should be, according to our extensive data.”
These are truly staggering statistics that point to a UK wide problem which can only be resolved by landlords realising the risk they’re running and making sure their buildings are insured for the right amount.
We’ve already mentioned that the underinsurance gap widens when the economy is under pressure, and in the current climate we’ve all noticed that the cost of everything – from food to fuel – has gone up. And insurance is no exception. Some of this is down to inflation, but this is not the only reason.
‘Index linking’ is a way of making sure that the value of a financial product is protected against rises in costs in the wider economy. A facility is put in place to track rises in costs – such as inflation and the cost of living – and then a similar percentage increase is applied to the value of the product.
In the case of buildings insurance, index linking typically relates to the rebuild costs of a property, which includes the labour and professional services that are required to rebuild the property, on top of inflation.
Due to a number of factors, index linking has increased rapidly since the beginning of 2022, when it was around four to five per cent. This affects landlords because landlord insurance covers the cost of rebuilding the property if it is damaged beyond repair. The Building Cost Information Services (BCIS) house rebuilding cost index showed an 18.2% annual increase to October 2022.
“I have been working in the insurance industry for more than 30 years and I’ve never seen index linking reach double figures, let alone the figures we are currently seeing, which are heading towards 20%.”
Steve Barnes, Head of Broking at Total Landlord Insurance
Although the increase in index linking is mainly due to inflation, it is considerably higher than inflation. This is due to other factors which include:
There are some signs that the situation may be getting a bit better in terms of supply, but not in the short term and much depends on factors out of our control, such as the Ukraine war, so the situation remains uncertain for the foreseeable future.
The true cost of underinsurance
To underline the consequences of underinsurance, let’s look at a Total Landlord Insurance case study.
In November 2019, a tenant set fire to a property causing extensive fire and smoke damage throughout. At the time of the claim, the property was insured for a rebuild cost of £88,000 but it should have been insured for at least £124,000.
This meant that the property was only insured for 71% of its actual value. The fire claim amount was £35,414 but as a result of the underinsurance, the insurers applied the average and only 71% of the claim was paid out, in total an amount of £24,894.
That’s approximately £10,000 that could have gone towards rebuilding costs that the landlord will never see, which could have been the difference between that landlord being able to bring that house back up to a liveable state or having to sell it on as a write-off. It’s a situation that could potentially trap owners of the thousands of underinsured properties in the UK right now and it begs the question – with so much to lose, why are so many landlords underinsured?
Is it a deliberate route to a cheaper premium or is it simply the result of general confusion and a lack of information?
More importantly, what happens if you are underinsured and how might you get out from under it or avoid it entirely?
It’s a common misconception that landlords only underinsure properties as a means of chasing cheaper premiums, when it’s more likely to be that they have failed to include everything when calculating the rebuild cost. The ‘buildings sum insured’ is the cost of rebuilding the property if it were to be completely destroyed, and should include things like the removal of debris and any professional fees. It’s easy to overlook these costs, but they all add up.
While it is true that premiums have been impacted by the current rate of index linking, the reality is that landlords are not going to save a great deal of money by doing this. For example, with the current rate of index linking, a £200,000 rebuild at the start of 2022 is now costing around £235,000. This extra £35,000 would add around £50.00 to the annual premium, depending on your postcode.
It's also worth knowing that there are steps landlords can take to protect themselves against any increase in insurance premiums. For example, if you rarely make claims it might be worth increasing your excess as this will reduce your premium without affecting your level of cover.
Instances of underinsurance are just as likely to be the result of confusion and lack of information as they are a deliberate route to a cheaper premium. More often than not, it’s simply a case of understanding everything about the property, as well as its rebuild value and market value. Let’s start by breaking down the reasons why landlords might be underinsured.
As we’ve mentioned, buildings insurance works on the basis of rebuild value, as opposed to market value. If you insure your property for less than the rebuild value then it is underinsured. This would mean that in the event of a claim, insurers will not pay the full amount, they will apply what is known as ‘average’.
If a tenant causes damage to a property for example, the landlord would not be able to make a claim unless they had taken out specialist buy to let insurance.
With a specialist policy in place, landlords can avoid any unnecessary financial loss should the worst-case scenario actually happen.
If a landlord underestimates the time it will take to get the property back to a liveable or workable condition following an insurance claim, the loss of rent insurance may not cover a long enough period.
Carrying out improvements to your rental property such as adding an extension will increase the value of the property, but will impact the insurance value too.
Similarly, a common underinsurance scenario occurs when a property owner simply renews their insurance policy year after year without making any updates that take market inflation into account.
Getting out of an old underinsured policy before taking out a more practical specialist policy is often quite simple as long as you haven’t made any claims during the policy year. You might even find that you’re still in your ‘cooling off’ period. Note, however, that if you are not still within this period you might need to pay administration fees upon leaving.
Before we go into exactly how you can avoid becoming underinsured and falling into severe financial losses in the event of an incident, let’s examine some of the terminology you might be faced with.
Buildings sum insured – The ‘buildings sum insured’ refers to the cost of rebuilding the property if it is completely destroyed, including demolition, debris removal, local authority and professional fees, which can add up to 15% to the overall costs so shouldn’t be neglected.
The average – The ‘condition of average’ in underinsurance states that the landlord bears a proportion of any loss if the property was insured for less than its full rebuild value. For example, if a landlord insures their property for £100,000, and makes a claim a few months later for £50,000 following an accidental fire.
The insurer assesses the actual rebuild cost to be £200,000, therefore only 50% of the actual value is covered. In this scenario the insurer applies ‘average’ which means only 50% of the £50,000 claim would be paid, leaving the landlord with £25,000.
Market value – This is the current value of the property on the rental market – the price at which the property has been valued on the real estate market.
Rebuild value – Not knowing the rebuild value of the property is perhaps the most common reason why properties remain underinsured, because rebuild costs are more difficult to ascertain than simple market value. But it can be done with a little help, which we’ll cover below.
Loss of rent – Loss of rent insurance covers the money you would lose if your property became uninhabitable due to an insured event that would force your tenants to move out. Loss of rent insurance enables you to claim back the lost income.
The rebuild cost is the amount of money it would take to rebuild your home completely from scratch. This needs to take into account the price of labour and materials needed to build a house identical to yours on the land you own. The sum is often (but not always) less than the market value because factors like land, location and desirability are not factored into the price.
To work out the rebuild cost yourself, first you’ll need to work out the floor area of your home, multiplying it by two if the property is two storeys. Then you’ll want to hire a surveyor, who will be able to take you through all of the costs with detailed measurements and a breakdown of every expense. Note that a surveyor should be able to offer a detailed rebuild cost even if your home is historic, listed or not built from brick.
There are tools available that help to simplify the process, such as the BCIS calculator or the Association of British Insurer’s online calculator, which also takes into account every other aspect of your property, including local and regional housing trends. However, all these can offer is rough estimates.
If you’re still uncertain, you can get a survey from a RICS member to be totally confident that your rebuilding value is correct. This is particularly important if your property is of non-standard construction or in a conservation area where it may be more expensive to rebuild due to the materials that may be required.
RebuildcostASSESSMENT.com carried out some research back in 2019 to find out how brokers’ clients were setting their buildings sum insured (BSI). The findings revealed that only one in 20 had a dedicated rebuild cost assessment completed by a regulated RICS company and over a third had used the market value. Alarmingly, 20% had simply guessed.
This is particularly important if you have extended or altered your property, or if property prices have increased significantly. A professional valuation will take every aspect of your property into account such as local and regional housing trends.
For an in-depth calculation, meanwhile, we’d recommend using RebuildCostASSESSMENT.com to provide an insightful on-site or remote property valuation.
For sum insured purposes the value needs to include not only the main structure of the building but also external areas, walls and anything else on the site. The value will also need to include costs of demolition and removal of debris, costs of rebuild and materials and professional fees for services such as architects and surveyors associated with rebuilding. Professional fees can add up to 15% to the overall costs.
It is important to take out a residential landlord insurance policy as a standard home insurance policy will not protect you in the event of negligent tenant behaviour or damage to the property. You should also check that your policy is index linked - this will increase your buildings sum insured at each renewal by a percentage based on the BCIS House Rebuilding Cost Index. Find out more in our article, why landlords need to understand how index linking affects their let.
Include everything (and we mean everything) – For sum insured purposes, the value needs to include not only the main structure of the building but also external areas, walls and anything else on the site.
If you are even remotely uncertain regarding whether or not your properties are underinsured – and in the current climate there’s a good chance you are - then it’s imperative to act now before it’s too late. Don’t wait until you need to make a claim – address any potential issues today by contacting your insurer to make sure that you are not underinsured.
If you have any questions about underinsurance or would like to discuss landlord insurance with one of our experts, please contact the Total Landlord team on 0800 63 43 880 or email enquiries@totallandlordinsurance.co.uk. Or alternatively get a landlord insurance quote online today.
