CONTRIBUTORSElite AgentEPM: Best Practice & Legislation

Sharon Fox-Slater: beware the underinsurance trap

The recent floods in Queensland and New South Wales have again highlighted the issue of underinsurance, with many victims not fully covered for repair and rebuilding costs. Sharon Fox-Slater examines the scope of the problem, why underinsurance happens and what you can do to assist your landlords and tenants.

Under-insurance is rife across Australia but it’s often not until a natural disaster strikes that many landlords find out the hard way that their investment properties aren’t fully covered. 

Would you be surprised to learn that it’s been estimated that 80 per cent of property owners may be under-insured and risk facing significant expense if they need to make a claim? 

Under-insurance happens when the policyholder has insurance, but the limits of the policy are not enough to cover the cost of loss or damage to the property.

A policyholder is usually considered to be underinsured if their policy covers 90 per cent or less of the rebuilding costs of their property.

Some landlords choose to deliberately insure their rental for less than it would cost to replace, often ascribing to the ‘it’ll never happen’ school of thought and a desire to save money on the premium.

This can lead to significant out-of-pocket costs when it comes to repairing or rebuilding, and may even put replacing lost assets beyond reach. 

Others find themselves underinsured by accident. 

Under-estimating replacement costs

A leading cause of under-insurance is the landlord underestimating the costs to repair or replace their property (the building itself and the contents including items within the premises that the landlord owns, not tenant possessions).

This leads to inadequate sums insured being nominated.

This scenario is increasingly common.

The pandemic has led to supply chains faltering, stretching re-build timescales as materials are unavailable or take longer to be delivered.

Building costs have also soared off the back of material price increases and labour shortages. 

Add in the impact from a slew of recent natural disasters – which have pushed house repair costs even higher and added to the building industry’s already stressed supply chains, putting an inflationary squeeze on prices and availability of materials and labour – and the risk of underinsurance compounds.

Even landlords who were adequately insured 12 months ago could now find themselves underinsured simply due to the increased cost of repairing, replacing or rebuilding their assets.

Prior to the pandemic, a survey conducted for the Insurance Council of Australia (ICA) found 83 per cent of households believed they may be underinsured when it comes to property insurance.

According to one quantity surveying company, that figure is likely to be much higher now given the increased replacement costs stemming from the pandemic and natural disasters.

So unless the landlord has reviewed their sums insured recently, they may be underinsured.  

Failing to understand severe weather risks

Many owners also don’t understand the risks, particularly of severe weather events, that their property faces.

For example, a survey conducted in March among residents in Queensland and NSW suggested many weren’t adequately insured against extreme weather events such as floods, bushfires or storms.

Despite a report on natural perils finding Queenslanders are at high risk of cyclones, around 23 per cent of owners believed they were at no or low risk.

Owners in Brisbane and Sydney are at a medium risk of bushfire but around 22 per cent said they had no exposure to bushfires.

Properties in NSW (metro and regional), Brisbane and regional Queensland are at a high to medium risk of flooding, yet around 44 per cent believed they were at low risk.

As a result, owners can find themselves underinsured due to an incorrect perception of risk. 

Sadly, it’s often not until a natural disaster strikes that underinsurance becomes an issue.

A natural disaster means high demand and higher costs – which then leads to underinsurance. 

Another quantity surveying company noted that an owner could be paying up to 50 per cent more to rebuild the same house following a large-scale flood or disaster than they would on an individually impacted home.

They also said that replacement costs vary greatly from location to location, noting it could cost twice as much to rebuild exactly the same home in a regional area following a large-scale disaster event than it would to rebuild it in the middle of Sydney.

The cost variation is attributed to supply and demand, labour, materials and accessibility.

Properties in disaster-prone areas are often also more expensive to repair, reinstate and rebuild due to the need to implement risk mitigation measures (building standards) at the property, such as Bushfire Attack Level (BAL) bushfire features, cyclone proofing or flood protections.

Disasters highlight underinsurance risks

The recent floods in Queensland and NSW have highlighted the risks owners face when their properties are damaged but their insurance is inadequate.

About 170,000 insurance claims have been lodged with a value of around $2.4 billion – but that’s only the insured losses.

Given the number of uninsured and underinsured properties, the real damage cost of the floods is much higher.

Experts have warned of a ‘devastating wave of underinsurance’.

A survey of people from three flood-prone regions in south-east Queensland and NSW conducted by the ICA found 37 per cent wouldn’t have enough insurance to rebuild.

Landlords who are underinsured could find themselves having to raise the money to rebuild their rental or risk losing their investment, not to mention their tenants losing their home and their agent losing business.

The problem with underinsurance

Insurers base premiums on the nominated value of the property and its contents (sums insured). As they have only collected premiums based on that value, insurers are entitled to calculate any payout using those nominated figures.

This means, that in total loss cases, an insurer will only pay to the maximum that the property and its contents have been insured.

For example, if a property is insured for $300,000 but the actual replacement cost is $400,000, the insurer will only pay out to a maximum of $300,000, leaving the policyholder to cover the $100,000 shortfall. 

For partial losses, the costs can be pro-rata based on the insured value.

For example, a property is insured for $300,000 but the actual replacement cost is $400,000, meaning the property is only insured for 75 per cent of its replacement value.

An insured event results in a $100,000 loss.

However, as the policyholder only insured the property for 75 per of its actual replacement value ($300,000), the insurer will only pay 75 per cent of the loss incurred ($75,000), leaving the insured to cover the 25 per cent ($25,000) shortfall. 

Avoiding underinsurance

Landlords can often become underinsured over time without realising it.

To reduce the risk of your clients being underinsured, consider reminding them that they should periodically review their insurance and make sure their sums insured reflect the true cost of replacing their investment property and its contents.

And it might be an idea to have the numbers of a couple of trusted builders and quantity surveyors in your little black book of tradies so you can put your clients in touch too! 

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Sharon Fox-Slater

Sharon Fox-Slater is the Managing Director of EBM RentCover, which protects more than 165,000 rental properties across Australia. For more info, visit RentCover.com.au.

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