Most commercial property insurance contracts have what is known as a Co-Insurance or Under Insurance clause; which allows an Insurer to penalize a client who under-insures. The principle is to encourage clients to fully insure and to penalise those that don’t.

Below are two examples of the Co-Average application:

Total Loss Scenario

– Actual Replacement value of property $500 000
– Your Sum insured $300 000

– The property suffers a Total Loss

The insurance company will pay you $300,000 although to replace it will cost $500,000.

Not so bad you might think? You are getting the amount you elected to insure, even though it won’t replace your asset. Where under insurance becomes a real problem is on a partial loss!

Partial loss scenario

– Replacement value of property $500 000
– Sum insured $300 000

– Total amount of loss suffered $100 000

The insurance company will calculate the loss on the following formula:

Sum Insured $300 000 divided by Replacement Value $500 000 x 100 = 60%
(You have only insured 60% of the actual replacement value)

The insurance company would pay:

Insurer contributes (Loss suffered $100,000 x 60%) = $ 60,000
Your contribution (Loss suffered $100 000 x 40%) = $ 40,000.

Most contracts will allow at least a 10% safety net. If your sum insured is at least 90% of replacement value they will not ask you to contribute.

What is the correct replacement value? The replacement sum insured not only includes the cost to replace the asset – new for old. It should also include additional costs the insurer promises to pay, such as:

  • Removal of debris,
  • Legal costs such as discharge of mortgages, etc.,
  • Planning, re-design & other professional fees,
  • *Extra costs to reinstate the property,
  • *Catastrophe cover

*Extra costs to reinstate are costs to comply with Federal, State, or Local By-laws. It could mean you now have to include handicap facilities in a new building, the council may tell you to include parking facilities. These are extra costs over and above the normal replacement costs of an existing building.

Unfortunately when catastrophes such as cyclones, earthquakes or bushfire occur, construction costs increase significantly due to the increase in local demand. This can be around 30% or more.

The most effective way to ascertain an adequate replacement level is to obtain a professional valuation. If you have bank valuations, please do not use the “market value” stated. Look for the “Insurance basis of settlement” value. Usually if the valuer has done their job they will either; have included this figure in the valuation document or, you may contact the valuer and request the figure.

At the very least talk to us about an adequate level of coverage. As your insurance broker we are not qualified to know what the values should be, however we can guide and assist you to formulate an adequate replacement level for piece of mind.

If you require further advice or assistance please contact our office.