Avoiding Over-Insurance?
Avoiding Over-Insurance? Here’s what you need to know
"You have too much insurance,” is not a phrase commonly heard from insurers. However, the truth is, being over-insured is a genuine concern. Here’s what you need to know."
The risks of being under-insured are well documented, highlighting the importance of having sufficient cover for your investment property. However, what isn’t as widely discussed are the risks associated with being over-insured.
So, what exactly is over-insurance?
Over-insurance occurs when a property is insured for more than it would actually cost to replace. For instance, if you nominate a sum insured of $1 million for the building, but the actual cost to replace it is $750,000, you are considered to be over-insured.
Why is over-insurance a bad thing?
For one thing, over-insurance results in unnecessary expenses. When a property is insured for more than its actual value, the premium tends to be higher. Consequently, if the property is over-insured, you're likely paying excessively for your policy. Essentially, you're paying a premium based on a higher valuation than you could recoup in the event of a claim.
But why can't you recoup the total sum insured?
Most insurers will only reimburse you for the actual cost of the loss you have suffered.
Let’s revisit our example…
Suppose you've insured the property for $1 million, and it experiences a total loss due to a fire. After assessing the repair and/or replacement costs, the insurance assessor determines that restoring the property to its pre-fire condition would cost $750,000. In this scenario, your insurance pay-out will be based on the assessor's valuation, not the $1 million for which the property is insured. So, despite paying premiums based on the property's $1 million valuation, you'll only receive $750,000 from the insurer, as that's the assessed value. In essence, you've paid more for no additional benefit.
Insurers typically do not refund any premium overpayment resulting from over-insurance. They won’t reimburse the difference between the higher premium you paid and the actual premium you would have paid if the sum insured had been accurate.
But why do insurers enforce this policy?
Many insurers include a clause in their policy regarding over-insurance, stating, “if you over-insure, we will not pay you more than it costs us to rebuild, repair, or replace. We will not refund any premium overpaid for over-insuring…”
Regardless of the policy wording, an insurer is generally only obligated to pay out the value of the property that has been lost or damaged. This precaution is in place because a policyholder may be tempted to profit from a loss, which constitutes a 'moral hazard' for the insurance company.
Engaging in such behavior is ultimately considered deceptive. For instance, a policyholder may over-insure a property and pocket the difference between the actual loss and the insured value. Therefore, safeguards like the over-insurance clauses are implemented to deter such practices.
Getting the sums insured right:
When obtaining landlord insurance, it falls upon you to ensure that the sums insured are accurate. The goal should always be to procure the appropriate coverage at the right price. This entails getting your sums insured correct to ensure you have adequate cover.
Here are some tips for determining the sums insured:
- Calculate the cost of replacing the building structure, including fixtures and additional features such as sheds, decking, driveways, pool, and fencing. Ensure the sum insured is based on current building costs rather than market value, as the latter doesn't reflect replacement costs.
- Determine the sum insured based on your own possessions within the rental property, excluding your tenants' belongings. It's essential for tenants to have their own contents insurance policy to cover their possessions.
- If you own property within a strata complex, review the body corporate's strata insurance to understand what is covered. This helps identify what needs separate coverage.
- Utilize online tools like the Cordell Sum Sure building insurance calculator and the Home Content calculator found on the ICA’s website for accurate estimations.
- For precise rebuilding figures, consider hiring a quantity surveyor or local builder to conduct a detailed costing.
- Periodically review the sums insured. Replacement costs for both building structures and contents can change over time, so it's crucial to base sums insured on current figures when initiating or renewing your policy.
If you are doing your own calculations:
- Only include the cost of the property/structures built on the land. Exclude the cost of the land itself from your calculations.
- Ensure that your calculations are based on current building costs, accounting for any updates or changes in construction expenses. Incorporate current building standards, including requirements for risk mitigation such as bushfire, flood, or cyclone proofing.
- Factor in the cost of any structural improvements made to the property, such as sheds, pergolas, or fencing, when determining the sum insured.
- Include the cost of removing debris and any associated fees, such as architect and council fees, in your calculations. These expenses are part of the overall replacement cost.
- Don't forget to account for GST (Goods and Services Tax) when determining the sums insured. This applies to construction costs and other associated expenses.
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