Commercial building insurance – a summary of what average means
It is always best to use a real life example when trying to explain certain aspects of commercial and business insurance. When you speak to a business insurance broker, particularly at quote stage, mention may be made of average being applicable. But what exactly does this mean?
In the actual policy wording, you will not see mention of an “average clause”, even though this is how we describe it. The part of the policy wording you are looking for is the “reinstatement” condition or clause. As with all aspects of an insurance policy, it is a legally binding contract between you and the insurance company. The policy sets out what the insurers, will and won’t pay out for. It also includes certain things which you, the insured, must do.
The average clause is one such part of the wording which defines how much an insurer will pay out, compared to the amount you have insured. Using the example mentioned above, we had a potential customer telephone us. There was a converted building in Wiltshire, which was Georgian and converted into four, sizeable, flats. The management company had gone bust and there was an absentee landlord. The ground lease was less than 60 years. One of the flats was being sold. On top of the purchase price you would have to pay a few thousand pounds in legal fees to get the lease extended. As the management company had gone bust along with the absentee landlord and the reduced lease, a mortgage was not available from a standard high street or even high risk lender. Our customer was a cash buyer and was paying around £60,000. The “real” market value was around £175,000 but he only wanted to insure for £60,000, to cover his investment.
We had to explain that, because of the average clause, he would have to insure for the full rebuilding cost for his own flat. This meant that whatever he was paying and the real purchase price the actual rebuilding cost would be different. Given the size of the flat, where it was, the age and its location in the block (underneath another) we agreed on a rebuilding cost of £225,000. This is the amount that it would cost to rebuild his flat, from scratch, in the event of a worst case scenario disaster, such as a fire. This amount needs to include all architects, surveyors and legal fees as well as rebuilding costs and site clearance fees. The actual rebuilding cost is only usually around 75-80% of the overall cost. The additional 20-25% is the legal fees and additions.
If the client did not insure for the full rebuilding cost, then there would have been a problem with a future loss. If an insurer decided to inspect the damage, they will estimate what the rebuilding cost should be. If he had only covered it for the £60,000, then an insurer would have said that the property would be under insured. If you are not paying the full premium for the risk as it stands, then you cannot expect the full claims settlement to be made.
What they will do is to divide the sum insured, on the policy, by the actual rebuilding cost, to get a percentage. In our example, this would be £60,000 divided by the correct rebuilding cost of £225,000. This means that the sum insured of £60,000, is only 26.6% of the correct sum insured. Therefore any claims settlement will only be for 26.6% of the amount claimed.
Insurers do realise that it can be difficult to keep a track of the sums insured at all times. This is why, in their reinstatement clause, there is a margin for error. This is a percentage amount which they will allow between the sum insured and the actual rebuilding cost. Usually this is 85%. Therefore, in our example, if the sum insured were between £225,000 and £191,250 (85%) then you would not be penalised. If the sum insured on the policy were below the £191,250, then the average clause would kick in.
It is a confusing clause, to the uninitiated. This is why you should always seek advice from an independent business insurance broker when seeking a quote.
