- What is index linking?
- How does index linking work with insurance?
- Rebuild value of a property
- Is rebuild value the same as market value?
- What are the benefits of an index-linked insurance policy?
- What other insurance products are index linked?
Index linking (also known as indexation) is the adjustment of an asset’s value to reflect inflation and deflation.
Insurance companies use various indices to measure the average change in value of assets. If an insurance policy is asset linked, any pay-out will better reflect the current value of the insured items. This means, for example, that if you make a claim on your contents insurance for stolen items of jewellery, the pay-out you receive will be based on the value of those items at the time of the claim, and not at the time you took out the policy.
- Luke takes out a home insurance policy in October 2020. The rebuild value is calculated at £210,000.
- In October 2021, Luke’s index-linked policy is renewed. According to the House Rebuilding Cost Index, the average estimated cost of rebuilding has risen by 8.8% since October 2020.
- Luke’s renewed policy is updated to show the rebuild value of his house as £228,480 (£210,000 + 8.8%).
The BCIS is operated by the Royal Institute of Chartered Surveyors (RICS) and commissioned by the Association of British Insurers (ABI) to provide guidance on rebuild valuation. The House Rebuilding Cost Index, which is available to surveyors, property owners, and insurance services, exists for the purpose of index-linking sums insured and as a model for adjusting renewed policies.
A domestic buildings insurance policy will usually require the sum insured to be the full cost of rebuilding the property. Rebuild costs include:
- Surveyors’ and architects’ fees
- Demolition and clearance of debris
- Materials and labour for the rebuild
- Alternative accommodation whilst work is being carried out
Besides the building’s structure, a rebuild includes permanent fittings such as plumbing fixtures, the kitchen, and built-in wardrobes. A buildings insurance policy may include outbuildings, like sheds, garages, and greenhouses, and some might also include boundary walls, pathways, gates, and fences. It’s important to check your policy carefully so you know exactly what assets are covered and what costs are accounted for in the rebuild value.
Rebuild value is not the same as market value. Usually, the cost of rebuilding is lower than the property’s market value. There are two major factors to consider.
Firstly, the value of a property is made up of land value and building value. Land value is not applicable in the rebuild calculation. However, in cases where non-standard materials or extraordinary building methods are required – for example, with a listed building – the gap between rebuild cost and market value can close.
Secondly, the market value of a property is influenced by location and demand. For example, in Durham, the average estimated rebuild cost (£222,000) is 65% of the average estimated market value (£341,500). In London, the average rebuild cost (£255,000) is only 39% of the average market value (£656,000).
Index linking an insurance policy gives some protection against being underinsured.
Being underinsured isn’t simply about receiving a pay-out that is less than you expect or need. It can mean that your policy is deemed invalid, or your insurer could employ the “average clause”.
The average clause in a policy applies to the overall proportion of undervaluation.
- Harry takes out a buildings insurance policy, with a sum insured of £200,000 for the rebuild value.
- The house suffers fire damage, and Harry makes a claim for £3,000.
- The insurance company discovers that Harry is underinsured. The true rebuild cost is £250,000.
- Because Harry valued his house at 80% of its true value, the insurer decides that Harry is only 80% insured.
- Harry only receives 80% of the amount he made a claim for: £2,400.
Indexation keeps a valuation accurate and valid. If your policy is index linked, the rebuild value of your home will be updated when you renew. Index linking means that you don’t have to worry about the fluctuating value of your home and trying to calculate the rebuild cost each time your policy is renewed.
However, it’s not advisable to rely on indexation for more than five consecutive years. Periodically, your property should be valued by a qualified surveyor. Remember that all indices are modelled on average costs and materials, and that indexation is not a guaranteed accurate valuation.
Contact Alan Boswell Group for more information about index-linked insurance and the importance of accurately calculating the sum insured on your policy on 01603 218000.