Technical Bulletin – Value at Risk – Buildings and Plant and Machinery – September 2018
Dear Broker Colleague,
When a loss is notified to you by a Client one of your first thoughts may be whether the sum insured is adequate or not. Policy wordings vary in the context of penalties for under-insurance but in light of recent building cost increases I think it is relevant to review the matter now.
SCSI announce “Celtic Tiger” level construction costs:
The Society of Chartered Surveyors Ireland (SCSI) announced in August of this year that construction costs are on course to be back to the same level they were in the first half of 2006 and just five index points below the peak in the first half of 2007. The 2007 levels were deemed unsustainable and we all know what happened after that!
The recession saw a wholesale “clear out” of construction companies with many failing and this period also saw the exodus of skilled labour due to lack of employment. There is currently therefore a significant skills shortage experienced by both main contractors and specialist sub-contractors dictating wage costs are constantly increasing.
In addition, steel and timber costs are increasing due to global influences and clearly there are other uncertainties in the market including Brexit and possible tariffs arising from various trade wars.
The consequences of the buildings regulations in terms of health and safety are having an affect on costs as is the Nearly Zero Energy Building Regulations in the context of insulation etc.
Clearly there is now a greater level of activity (arguably in the Dublin area) and competition has an influence on price and the continued rise in tender prices over a relatively short period may have an influence on the ability of contractors to trade as demonstrated recently in a number of school delivery projects.
The SCSI Tender Price Index tracks the bid levels when construction firms tender for contracts and the quarterly update produced in August 2018 shows that prices increased by 3.95% in the first half of 2018. The forecasted annual increase for 2018 is at 7.4% dictating that construction prices are near the levels of 2006 and 2007.
Dublin now ranks as the sixth most expensive place globally to build according to a survey carried out by the Turner & Townsend International Construction Market Survey 2018. They place the average construction cost in Dublin at €2,608 per metre square. Turner & Townsend indicate that demand for new development has driven a surge in construction activity in Dublin and that natural cost inflation is being exacerbated by skill shortages.
With a limited number of contracting firms dominating the high-level construction market in this country it could be argued that that rate of €2,608 per metre square (€245 per square foot) should not differ significantly in regional cities or areas.
Value at Risk (VAR)
So where does this leave you as a Broker in terms of advising your Client at inception or renewal in terms of the buildings sum insured? The normal approach is a rate per metre square but clearly each case has to be dealt with in isolation.
In this respect an older building could have an asbestos roof attracting significant demolition and disposal costs or a warehouse structure could have piled foundations or specialist floors. A commercial office or retail unit could be in a terraced location in a narrow busy city centre area dictating that access/permit issues, demolition, shoring up etc all have to be brought into the equation.
We have carried out an exercise in consultation with a number of firms of Quantity Surveyors and have produced a Schedule of Outline Costs in relation to a number of commercial buildings. We can discuss this with your Client in terms of their particular requirements etc.
Clearly each property needs to be taken on its merits. For example, underground parking would attract an individual rate given that there may be specific issues in terms of tanking etc. A commercial warehouse risk may be located on an extensive area of “hardstand” and clearly the valuation needs to take this into consideration but some Insurers may be open to a “First Loss” approach in that it is unlikely these will be exposed to a total loss. Similar arguments can apply in relation to foundations or piled foundations or extensive length of walls etc. Is it a listed or protected structure etc or does the build involve a unique design or a particularly challenging site etc?
The original construction cost is relevant provided it has been subsequently reviewed in the context of subsequent construction cost increases/decreases accordingly.
We recommend in every case in excess of €1million that a professional review be carried out which is a service this firm provides.
Plant & Machinery:
It often transpires that the Policyholder’s plant and machinery is incorrectly insured because the wrong value was set day one and was incorrectly indexed on an annual basis thereafter.
Another reason may be that no significant increases were subsequently applied because inflation was at a low level but the plant value should have been geared towards the exchange rate fluctuations from the country of origin given a replacement will be sought there.
Consideration needs to be taken in terms of the transport and installation or commissioning costs.
Occasionally Policyholders have incorrectly named assets or grouped assets in their Fixed Asset Register resulting in omissions or have used incorrect asset numbers etc.
The Fixed Asset Register is the starting point for the valuation exercise and should be updated in accordance with plant on site and in use. The original supply, installation and commissioning costs should be adjusted in terms of inflation and current replacement values established with Suppliers/Agents.
Clearly all plant and equipment at risk (Value at Risk) should be insured.
Policy Implications for under-insurance:
As we are all aware the criteria are the same if the sum insured is inadequate and invariably there is a proportional deduction to penalise the Policyholder on the basis that he has not paid a commensurate premium in terms of the Value at Risk.
The reinstatement value may be reduced to an indemnity value in the event that the sum insured is inadequate. If the indemnity value is inadequate then “Average” may apply on the indemnity calculation.
Both buildings and plant and machinery can be insured on a Reinstatement Memorandum or Day One basis to combat the effects of inflation during the currency of the Policy. The Reinstatement Memorandum gives a leeway of 15% for under-insurance but if the sum insured is less than 85% of the Value at Risk then “Average” applies. Day One cover provides for “inflation proofing” in that the Insured decides what inflation will be from the inception/renewal date through the period of insurance and this percentage is applied to the Declared Value to become the limit of liability/sum insured.
The important point for buildings and plant is that the sum insured is adequate at inception or the outset as subsequent inflation proofing will not correct this fundamental aspect.
Protect your Client!
As Chartered Loss Adjusters this firm provides a Value at Risk (VAR) service for both buildings and plant and machinery. We have carried out Value at Risk surveys on churches, hospitals, apartment blocks, large shopping malls and large multi-national food and pharma facilities etc. We prepare a detailed report addressing each item as set out in the Policy Schedule.
Our exercise is similar if not more detailed than that carried out by a Loss Adjuster or Insurer in the event of a significant loss. We charge our fee on a scale basis in accordance with the sums insured we recommend (fee scale available on request). As part of our service we can review the sums insured on an annual basis for a nominal administrative charge.
I sincerely hope you find the foregoing of interest and if you require any further information please do not hesitate to contact me.
Alan FitzGerald, FCII, FCILA, FUEDI-ELAE, 11th September 2018
FitzGeralds Chartered Loss Adjusters,
10B South Bank,
T: 021 4311979
F: 021 4311020
M: 086 8074553
Whilst every attention to detail is taken the above piece should be viewed as a thought piece to provoke some thought to the adequacy of your own insurance requirements and or relevant sums insured. Any sum insured arrived at should only be done so following the receipt of professional advice. The author and / or MBC Insurance would insist that the article not be relied upon in the calculation of your own unique sum insured