Full Replacement or Sum Insured?
Until approximately two years ago, most insurance policies for New Zealand residential property were for full replacement calculated on the square metre area of the house.
Understanding different levels of risk
The problem with this form of insurance was highlighted dramatically to the insurance companies after the Christchurch earthquakes when they discovered that they did not know the full extent of the risk. The problem was that the insurance companies were measuring risk based on square metres without reference to the cost of construction of different types of homes. It was entirely possible to build a house for $1000 per square metre. It is also quite possible to build a house spending $5000 or more per square metre.
Full replacement model
The insurance companies had promised to rebuild people’s houses to the standard they had previously enjoyed without adequately considering the actual cost of reinstatement. Whilst all claims were met by the insurance companies, the insurance companies determined that the full replacement model was not going to work in future.
Sum insured for residential property
Most insurance companies (with a few notable exceptions) have now moved to a sum insured basis for insuring residential property. The sum insured model allows an owner to determine for themselves the dollar figure that they wish to insure their property for. This model gives the insurance companies a very simple method of calculating their total exposure in the event of a significant disaster such as the Christchurch earthquakes. However, the new model has passed a significant risk on to individual homeowners.
The homeowner is now required to establish the total sum they wish to be covered for. It is tempting to simply use the capital value or purchase price as the sum nominated. However, in the event of a total loss, the costs of rebuilding will include rectifying the land (in the event of an earthquake or subsidence), clearing the site (including demolition), professional fees, local authority consent fees and construction costs. These costs can be very significant and in some cases may even exceed the value of the property. The nature of the site can dramatically affect construction costs.
Making sure you’re not under-insured
When my insurer moved to a sum insured model they nominated a sum insured for me and put the onus on me to determine whether or not it was correct. I instructed a valuer to provide me with a replacement construction cost. The valuer’s advice was to double the sum insured nominated by my insurer. In the event of a total loss I would have been 50% under insured if I had accepted my insurer’s figure. I would not have been able to re-construct my house with the insurance proceeds.
We recommend that all our clients closely review the sum insured level for their property to ensure that there is no prospect of them being under insured in the event of a complete loss.
Should you have any concerns about sum insured policies contact your insurance broker or us to discuss your options.