The obligations under the Insurance Act of ‘duty of fair presentation’ ensure risk managers understand the importance of accurate insurance valuations.
Price is what you pay, but value is what you get, Warren Buffett famously counsels investors. But when it comes to insurance and premiums, buyers face a different problem – the two are all too intimately connected.
Understate the value of a building or asset in search of cheaper insurance and you’re likely to find yourself underinsured when it comes to a claim.
It’s a frequent issue, according to Trevor Young, Senior Partner at JLT Specialty. Among small to medium enterprises (SME), the FCA’s report on claims in 2015 found an “alarming degree” of underinsurance.
Meanwhile, last November, the British Insurance Brokers’ Association (BIBA) launched a guide to help small businesses avoid problems.
Getting a professional valuation was the first of its ‘top tips’. However, SMEs are not alone in running into problems, according to Young: “It’s surprisingly common, and it’s a risk that needs to be better understood.”
Getting valuations right is even more important following the Insurance Act 2015, which came into force last year. The Act provides both a stick and carrot to promote improved practice.
On one hand, commercial clients have a duty of ‘fair presentation’ to disclose all material circumstances, including information to give notice to insurers where they ought to make further enquiries.
It is hard to see how this can exclude clear information on asset values and how these were determined. On the other hand, provided this is given, the opportunities for insurers to decline claims are reduced.
Once the valuation process has been signed off, as it were, there isn’t so much comeback for the insurer,” says Young.
“However, where there has been deliberate or grossly negligent misrepresentation of the valuation, then the insurer will retain the right to void the policy, even in cases where the valuation process was originally signed off and agreed.”
In some cases, of course, values are deliberately under or (less often) overstated. But it is also easy to go wrong unintentionally, says Susan Davies, Managing Director of specialist valuations firm Rushton International.
“The mistake could be using a net book value or a market value for the asset or property, which is not what it would cost to put back,” she says. Instead, insurers usually need a reinstatement value providing for costs such as demolition and clearing, as well as rebuilding.
Perhaps more commonly, valuations stray over time. A survey of brokers by Insurance Times and insurer Zurich in 2015 found that close to two thirds said a failure to carry out regular valuations was the main cause of underinsurance.
A range of factors should prompt regular revaluations.
In November, for example, BIBA reminded businesses to take account of currency fluctuations following the Brexit vote. These can have a huge impact of valuations, according to Davies.
‘Indexation creep’ is another common issue, where an initial accurate figure updated annually according to an index (to take into account inflation, for example) compounds minor errors until they become big ones.
“You gradually get further and further away from the true value because you are indexing indexed figures every year,” says Davies.
Regardless of the cause, the result of underinsurance is always the same – the policyholder risks a shortfall in their cover.
Don’t know what you’ve got ’till it’s gone
At claims consultant Echelon, Ian Fulton regularly sees the problems valuations 20 per cent or even 30 per cent lower than the actual value at risk can cause. In one recent flood case, the affected building was underinsured by 60 per cent.
In this case and similar cases, firms like Echelon can put forward a case for a higher valuation and work in other ways with the loss adjuster to negotiate a settlement.
In the case in question, for example, Echelon was able to successfully argue that a greater proportion of the loss fell under the contents cover, where there were adequate limits, rather than the buildings insurance in place.
“We did manage to lessen the effect, but only lessen it,” says Fulton. “There was no getting away from the fact they were hopelessly underinsured,” he says.
In these cases, insurers will usually apply average, reducing the claim in proportion to the amount underinsured.
Avoiding this is the principle benefit of having a robust, preferably professional, valuation process, says Fulton.
Insurers may agree at the outset to a less onerous average clause in the policy, so premises or assets are not individually named and itemised, making it less likely the insurer will apply average on any individual loss.
They may even agree to waive average completely, so that underinsurance ceases to be a possibility for that asset or property.
Robust valuations provide fair risk assessment
Particularly post Insurance Act, the certainty a robust valuation provides benefits both to the insurer and client. This is because it assists in providing a fair presentation of the risk.
Traditionally insurers have seen the challenges around valuation as the policyholder’s problem.
The Insurance Act provides an opportunity to persuade insurers to contribute to the costs of valuation. However, this change in insurance market attitudes remains to be seen, according to Young.
Nevertheless, there’s still a strong case to consider investing in professional valuations – and not just to avoid underinsurance. Proper valuations give a greater insight into the real risks the business runs.
“If businesses don’t understand where the values are located then they cannot work that through into a proper estimated maximum loss following an event,” points out Davies.
One service Rushton provides, for example, is a risk map, helping visualise the spread of values, and therefore risk, a business has across its sites.
As Young concludes: “Valuations help you really understand your exposures and your risks. They determine a lot more than just the sum insured.”
For further information contact Trevor Young, Senior Partner on +44 20 7558 3028 or email firstname.lastname@example.org