Too little or too much is a conundrum many landlords face when it comes to their insurance. While having too little (under-insurance) is rife among property owners, having too much (over-insurance) is also an issue, so landlords need to find the right balance to ensure they appropriately and adequately protect their investment.
Under or over?
Under-insurance is when a portion of a property has not been insured, or has been insured for less than it is worth. The Insurance Council of Australia (ICA) suggests that a property is under-insured if an insurance policy covers 90 per cent or less of the rebuilding costs.
Concerningly, under-insurance is rife among Australian property owners, landlords and tenants – with eight in 10 homeowners and renters being under-insured for their home and contents, according to the ICA. This is despite 83 per cent saying they could not resume their same standard of living if their property was badly damaged or destroyed because they did not have enough insurance.
There are two main reasons why landlords under-insure their investment property. The first is by accident, by which we mean they inadvertently fail to insure the property for the correct value by underestimating the cost to rebuild or replace contents.
The second is by design. There are some landlords who think ‘it’ll never happen’ and deliberately under-insure their property. But the few dollars they save on their premium becomes a false economy if they need to claim.
In total loss cases, an insurer can only pay to the maximum that the property and its contents have been insured; for partial losses, the costs can be pro-rata based on the insured value. Either way, any shortfall would need to be made up by the policyholder.
As an example, a couple of years ago the owner of an investment property in country Victoria insured the home for $162,000, knowing that the sum was inadequate but remarking at the time: “It will be fine, it’s not like the house will catch fire”.
The house did in fact catch fire and was a total loss. With the property costing $350,000 to re-build, the owner was left to find the $188,000 not covered by insurance.
Over-insurance is where the property is insured for more than its actual cash value or replacement cost.
Erring on the side of caution is wise when determining the sum insured to ensure the value is fair and reasonable, but overinflating the property’s value simply means the landlord will pay too much for their insurance, that is, they’ll be paying a premium based on a higher figure than they could recoup.
To ensure policyholders are not tempted to make false claims to profit from a loss, most insurers will only reimburse policyholders for the actual cost of the loss they have suffered, that is, only pay out the actual costs to rebuild, repair or replace property.
So if a rental is insured for $1 million and an insured event takes place and the property is a total loss, an assessor will determine the replacement cost, say $750,000.
The insurance payout will be based on the $750,000 and not the $1 million. The landlord will not pocket the extra $250,000, so they will have paid a higher premium for no benefit (and no, they won’t usually get a refund on the premium overpaid for over-insuring either).
Bottom line: An insurer is generally only obliged to pay-out the value of the property that has been lost or damaged – and only to the maximum that the property has been insured for.
Avoiding the pitfalls
Having cover in place is invaluable when things go wrong, but property investors and agents need to understand that the landlord’s insurer can only respond to a loss when the right type and amount of cover has been selected.
Here are four tips you can share with your landlord clients to help them find that Goldilocks spot where the cover they have is ‘just right’:
Assess the risks
- Landlords need to identify the types of risks they are exposed to, the likelihood of these occurring and their potential impact. As an agent, you may be well placed to help your landlords consider risks for their investment property given your knowledge of the local market and the area (including hazard ratings). With this knowledge, the landlord can look at how they can address the risks including taking out adequate insurance cover.
Select the right cover
- When taking out insurance, a landlord needs to determine what type of cover they need and then select the right policy for the type of property and the way it is rented. For example, they may need a policy that covers the building, contents and tenant-related issues (e.g. for a detached house), or a policy that covers property damage and tenant-related risks but not the building itself (e.g. for an apartment, flat, unit, townhouse), or a policy that covers short-term rental.
Ensure the sum insured is adequate
- It is crucial for landlords to understand how much it would cost to replace their investment property and its contents. It is important for them to remember that building costs and standards change and they need to base the sum insured on the current building replacement cost (not on the original purchase price or current market value). To get accurate costs, landlords should engage a quantity surveyor, builder or sworn independent valuer to get an accurate estimate (tempting as it might be to weigh in on this, as an agent chances are you aren’t actually qualiifed to provide this advice – so don’t!).
Alternatively they could use online calculators like the ones on the ICA website. The sum should be based on the cost of replacing the premises and contents on a new-for-old basis. The cost of the land should not be included, just the property/structures built on it including sheds, pergolas and fencing. And they shouldn’t forget to factor in other expenses such as demolition, debris removal, and architectural, engineering and council costs – and GST.
Review and update the policy
- Landlords should not set and forget but regularly review the sum insured to make sure it remains adequate and not just at renewal time, but if circumstances change. If they renovate the property or upgrade any contents (like appliances), they need to ensure they still have enough insurance cover to account for these improvements.
At EBM RentCover we offer reliable solutions to help property managers and landlords feel confident they are well protected by insurance.