Why is underinsurance a problem?
Due to the current climate the underinsurance gap is expanding.
We’ve already mentioned that the underinsurance gap widens when the economy is under pressure, and in the current climate we’ve all noticed that the cost of everything – from food to fuel – has gone up. And insurance is no exception. Some of this is down to inflation, but this is not the only reason.
‘Index linking’ is a way of making sure that the value of a financial product is protected against rises in costs in the wider economy. A facility is put in place to track rises in costs – such as inflation and the cost of living – and then a similar percentage increase is applied to the value of the product.
In the case of buildings insurance, index linking typically relates to the rebuild costs of a property, which includes the labour and professional services that are required to rebuild the property, on top of inflation.
Due to a number of factors, index linking increased rapidly at the beginning of 2022, when it was around four to five per cent peaking at 18.2% by October 2022. This affected landlords because landlord insurance covers the cost of rebuilding the property if it is damaged beyond repair.
Since then, index linking has decreased as house rebuilding cost inflation has calmed, but prices have not returned to the level they were at before 2022. The house rebuilding cost index was 40% higher in January 2024 than it was in January 2020.
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This is due to other factors which include:
The cost of materials, which have increased at an unprecedented rate and have reached a 40 year high (according to RICS), with steel prices up by 70%, timber up 35%, roofing materials up 50% and brick prices up by 44%
A shortage in skilled labour, which is triggering wage rises – with some builders reporting a rise of around 25% to attract the skills they need
The war in Ukraine and the impact on energy prices, which has put the construction industry into further turmoil
There are some signs that the situation may be getting a bit better in terms of supply, but not in the short term and much depends on factors out of our control so the situation remains uncertain for the foreseeable future.
Over a rolling 12 months, index linking has settled to around five per cent, which is a significant drop from the circular post-Covid increases, which peaked at nearly 20%. While this is a welcome easing, it doesn’t mean property owners can afford to be complacent. Rebuild costs remain substantially higher than pre-2022 levels, and it’s still essential to check that your property is adequately insured each year. I recommend having a professional valuation carried out at least once every five years to make sure your cover remains accurate and up to date”
In terms of the future outlook, BCIS construction industry forecast predicts that building costs will increase by 17% over the next five years. Dr David Crosthwaite, Chief Economist at BCIS, said:
“Sentiment in construction has changed significantly since the start of the year and, with economic growth stagnating and inflation starting to pick up again, stagflation is becoming a real possibility this year.
‘As a result, we’re forecasting that 2025 will likely be another difficult year for construction with only minimal output growth evident before growth accelerates later in the forecast period.
‘While the cost of borrowing is reducing, albeit slowly, we have yet to see increased levels of investment in built assets. Furthermore, we expect to see increases in both input costs and tender prices due to the National Insurance uplift, resulting in potential affordability issues.”
While there are some signs that the situation may improve over the next five years, this is unlikely in the short term. Prices have not returned to pre-2022 levels, with the cost of many raw materials remaining high. Ongoing shortages in skilled labour are continuing to drive up labour costs, and high energy prices continue to add pressure. The situation remains uncertain for the foreseeable future.
Landlords may also be at greater risk of underinsurance due to increasing risk factors. In a recent article for Insurance Post, David Williams, chair of the Fire Protection Association (FPA) and former managing director of underwriting and technical services at AXA, expressed concerns that properties are not adequately insured, citing two examples of risks the FPA is seeing more of in recent years.
Lithium ion batteries
The FPA is seeing more fires that have an electrical source to their ignition which may have a lithium ion battery connection, and the London Fire Brigade has reported that the fastest growing fire risk in London is battery-powered e-bikes and e-scooters, which are causing a fire ‘every other day’. Both landlords and tenants must be aware of the risks and make sure that e-bikes and e-scooters meet the correct safety standard and are safely stored – see our landlord and tenant guide to preventing e-bike and e-scooter lithium battery fires for guidance.
Solar panels and sustainable materials
While many landlords are making energy efficiency improvements to their properties for the benefit of the environment and their tenants, it’s important to understand the materials that are being used and take any necessary precautions to reduce risks.
The FPA is seeing an increase in large fires caused by solar panels, some of which are cheap, aren’t always built correctly and can be faulty.
Commenting on the push for more sustainable and eco-friendly materials being used to repair and build properties, Williams says:
“It is having a massive impact. Mass timber is great in certain circumstances, but wood burns. Therefore, it’s about understanding the materials that are specifically being used and applying preparators. It might be sprinklers, it might be water mist. And those are things that we in the UK have been very lax on.”
Williams highlights the direct impact of energy efficiency improvements on underinsurance. He says:
“I have a suspicion that a lot of these new materials are being invested in to save money in the long run through better insulation, better performance, etc, but we’re not seeing it in increased sums insured. We are seeing a sometimes quite staggering increase in underinsurance at the time of a loss.”
It’s important for landlords to be aware of these increases in risk combined with macro-economic pressures to avoid being underinsured.
