Understanding the insurance process for when taking out insurance or when claiming
When insuring your home or office building or industrial warehouse, the basis on which you need to insure is new replacement cost. New replacement cost is what it will cost to replace your entire house or building with an equivalent or similar structure. It is important to understand the insurance process before taking out insurance or when claiming.
The first step is your decision to get a quotation for insurance. Either you have an existing policy or are planning to switch based on the most cost-effective quote. You contact your insurer (if existing) and ask them to review your premium based on past claims (if you did not have many historical claims they might reduce your premium) or you request a quote from another insurer. In order for an insurer to provide you with a quote, they will ask you a few questions in order to determine your risk profile and very crucially they will ask you what your property is worth or what it needs to be insured at. This value is not market value. Although there are many knowledgeable property owners, determining the value of your property is not what you paid for it a few years ago or even today, neither is it what the municipality says it is worth. Your insurer insures your property on the basis of new-for-old, in other words they insure it on the basis of new replacement cost. In order to supply your insurer or potential insurer with a value on which they must quote you, you can either estimate the value yourself, which we will not recommend if you are not active in the property construction industry (but if you are, you should be close), or request a professional to estimate the new replacement cost.
The second step is you contacting a professional to do an assessment and using that report as basis for the insurance quote. If you are willing to have a professional estimator conduct the assessment, they will visit your property and take detailed measurements and photos. If you have the building plans available, this can assist the assessor in general terms to determine the layout of the property, which he or she will in any event draw if the plan is not available, and in determining whether there are any illegal structures on the property. We do not contact the municipality for the building plan as it is easier to do a physical site inspection than getting a letter from the owner and going to the municipality and applying for a copy (the process is faster). An important note on illegal structures is that it is not such a big challenge in the case of insurance. In other words, any additions or renovations made to the property that was not applied for and approved by the municipality is considered illegal. This means that the municipality can at any time inform you to remove the structure or demolish the addition. However, no one informs the municipality of this. When the assessor visits your property and the building plan is not available, he or she will continue with the measurements as per normal and compile their estimation later in the office. Unless there are obvious discrepancies like the garage is essentially on the passing road, illegal structures will not be noticed. Even if the structures are noted, the assessor only notes this in his or her report for the attention of the insurer. The insurer can then decide whether they would like to insure that portion of building or not. They normally do. Even if you submit a claim, they will pay-out the illegal portion. We are not advocating that property owners should build illegal additions or make renovations, however, neither the assessor nor the insurer are required to inform the municipality of the illegal structure. It is up to the municipality to identify the illegal structures and contact the property owner in this regard. The onus for the illegal structures lies with the property owner.
The third step is the estimation process. Although the actual process of estimation is what you are paying the estimator for, it would be beneficial to understand the process they have to go through in order to determine the estimated value. There are generally two approaches to estimating the value of a property for insurance purposes. There is the cost-effective and relatively short process which essentially takes the extent of your property, multiplies it with a R per sqm rate and adds some fees and provisions. This is a kind of a rough calculation. The second step is a detailed cost estimate. This approach takes detailed notes of the types and number of windows, types and length of skirtings, the thickness and finish and type of walls, the gradient and area and building material of the roof, the gradient of the foundation, etc. It is a detailed cost estimate of all the elements of your property looking at the building material itself and labour required to build it. Added to this is a number of fees and provisions such as preliminaries and site management fees for the builder to setup scaffolding, comply with health and safety etc, it includes the builder’s profit, a contingency for price changes or strikes causing delays in the availability of building materials, demolition of existing structures to clear the site for re-building, and professional fees of architects and estimators who manage the rebuilding process. Another important factor is escalation. If your garage burnt down, you need to re-apply for construction from the municipality, we include a waiting time of 4 months during which construction costs (material or labour) can change. There is also escalation of construction costs during the construction period i.e. while building. Finally, there is a future inflation allowance that is optional and can be included to ensure that you are accurately insured at all times. This entails a forecast of building cost inflation over the next 12 months and notifying your broker to increase the insured value on a monthly basis with this amount. If an event should occur during this period, your insurance will be up-to-date and no Value at Risk assessment will be required.
This brings us to the fourth step being the Value at Risk or VaR assessment. A VaR assessment is when you are insured for a certain amount and an event arises and you submit a claim. Let us continue with the example of the garage having burnt down. The insurer will send out an internal assessor who will assess the loss. If they think the amount for which you are currently insured are too low, they will contact an external professional, to perform a VaR assessment. This assessment is exactly the same as the estimation the estimator made in step 2 above when you were taking out insurance or comparing quotes. The estimator will visit your property, take measurements, photos, etc. Then they compile their report of the new replacement cost i.e. what it will cost to replace the full building today. Once the insurer receives the VaR report or assessment, the loss adjuster will make some calculations. If your insured amount is significantly lower than the VaR report, then the claim will be paid out based on average. You will probably be paid out your insured amount in some/most cases, but it will be less than the actual cost.
An important note is that the VaR assesses the replacement of all the improvements on the property. Unless requested, the actual loss calculation i.e. calculating the cost of only replacing or repairing the garage is done by the loss adjuster. The most common causes for a property owner being under-insured is either the initial value that they were insured at were incorrectly estimated or even if that value was correct, the insurer annually increases the value by 10% for up to +/- 5 years. This means that unless you advise the insurer annually what the insured value is to be, they will increase it by 10% every year. After +/- 5 years, they can request you to relook the value. The problem arises with the 10% increase as it might not keep track with building cost inflation. Sure, if the 10% is more than building cost inflation you will be over-insured which is fine from a claim point of view as you will be paid out, but you will be paying more than what is required monthly in terms of your premium. If the 10% is less than building cost inflation, then you will be under-insured and not receive sufficient pay-out. One of the benefits of employing a professional estimator before taking out your policy or when renewing is that they will have your property information on the system and can advise you annually what the insured amount should be at a fraction of the original cost and you are kept up-to-date with marginal chances of average occurring in the event of a claim.