What is index-linked buildings insurance?
By Alan Boswell Group
What is index linking?
Index linking is a mechanism used by insurers to ensure the rebuilding sum insured remains as accurate as possible. Index linking can also be applied to general contents and machinery and plant. The sum insured still needs to be set at an adequate level for reinstatement, otherwise you run the risk of under insurance. In this event the insurer is entitled to apply the General Average Condition and the insurer would be able to reduce any claims payment to the amount of under insurance. Index linking is not based on the general rate of inflation. It is calculated based upon the costs of raw materials, availability of labour, demolition and waste removal, professional services fees, plus any other costs associated with a complete rebuild of the property. We would recommend rebuilding surveys are undertaken at least every five years. Index linking will then assist with any increases to the buildings sum insured.
How does index linking work with insurance?
Insurance companies use various indices to measure the average change in rebuilding costs. Buildings insurance policies are index linked at renewal to account for any increase in rebuilding costs. In the event of a claim, the pay-out will better reflect the current value of the insured items. In the case of home insurance, the most widely used index for calculating rebuild costs is the BCIS House Rebuilding Cost Index, which is part of the Royal Institute of Chartered Surveyors (RICS.)For example:
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%).
Rebuild value of a property
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 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
Groundwork
Materials and labour for the rebuild
Alternative accommodation, or alternative business premises, whilst work is being carried out
Removal of asbestos, if applicable.
Besides the building’s structure, a rebuild includes permanent fittings such as plumbing fixtures and the kitchen. A buildings insurance policy may include outbuildings, boundary walls, pathways, gates, and fences, as well as common areas around a commercial property. 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.
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Is rebuild value the same as market value?
Rebuild value is not the same as market value. The cost of rebuilding could be higher than the property’s market value. 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 or commercial premises – the gap between rebuild cost and market value can wildly different. If the rebuild sum insured is too low the insurer will apply the General Average condition. For example:
Sum insured = £1,000,000
Actual rebuild sum insured = £2,000,000
Amount under insured = 50%
The insurer would reduce their claims payment by 50%, leaving you to cover the difference.
What are the benefits of an index-linked insurance policy?
It is the policyholder’s responsibility to provide the sum insured and to ensure it is accurate. Index linking an insurance policy provides 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. For example:
Harry takes out a buildings insurance policy for his warehouse and office, with a sum insured of £200,000 for the rebuild value.
The warehouse suffers fire damage, and Harry makes a claim for £150,000.
The insurance company discovers that Harry is underinsured. The true rebuild cost is £300,000.
The insurer decides that Harry is only 66% insured.
Harry only receives £100,000 towards his claim (£200,000 / £300,000 x £150,000 = £100,000)
Index linking assists in keeping a valuation accurate and valid. If your policy is index linked, the rebuild value of your property will be updated when you renew. This means that you don’t have to worry about the fluctuating value of your property 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.
What other insurance products are index linked?
Many insurance policies, including income protection insurance, landlord building and landlord contents insurance, critical illness insurance and commercial property insurance, are index linked. 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.