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Business Property Insurance: the importance of declaring your insured assets correctly!

Business Property Insurance: the importance of declaring your insured assets correctly!
23-06-23 / Tau kaVodloza

Business Property Insurance: the importance of declaring your insured assets correctly!

Johannesburg -  Businesses rely on their assets to maintain efficient operations, such as tangible property, plant, machinery & equipment, furniture & fittings, computers, through to vehicles, warehousing and stock.

In many instances, risks such as fire, theft or flood that result in the damage of assets, can compromise key business processes, with subsequent impact on the ability of the business to continue operating as efficiently as prior to the incident. This is referred to as consequential business interruption losses, directly resulting from the asset damage incurred. 

Consider for example if a business experiences a catastrophic fire and a key manufacturing plant is destroyed. The value of the loss would not only be in terms of the damage to the building, plant & machinery, but also the lost income as a result of not being able to produce. If the insurance declared values for the material damage and business interruption are incorrectly stated by the insured on the policy, the resulting settlement by the insurer/s can be significantly less than expected, and or needed for the business to recover to continue as a going concern.

Factors affecting the complexity of the insured value of loss, is further aggravated, where:

  • the original plant and machinery to be replaced, must be imported, or is no longer in production. As insurers settle on ‘New Replacement Value’ and not ‘Book or Acquisition value’, there will no doubt be additional costs (Civils; Electrical; Forex; Transport etc) for workarounds if a different, but similar specification plant is the replacement. These factors contribute to what the ENVR (Estimated New Replacement Value Declared) should be. 
  • or a destroyed building to be rebuilt, costs significantly more to ensure compliance with latest building regulations.

“It is imperative that a current and accurate ‘Fixed asset register’ is maintained. Professional valuators can then review and update the asset register annually, to ensure the declared values are consistent with the anticipated insured periods, (a loss could be 11 months after declaration). The register will then be able to provide for the accuracy of an insured’s annual property declarations and for the correct insured values to be attached to each asset, in accordance with the required insurance indemnity, normally the ENVR,” explains Craig Kent, head of risk consulting at Aon South Africa.

The consequences to a business in the case of loss if the declared values are inaccurate, can be quite debilitating.

Declared Values, defined:

Every entity seeking insurance will be required to submit declared values on all aspects of their insurance requirements - annually or periodically - as stipulated by the underwriter of the insurance provider. These values are based on the client’s view of their property and operational risk and may include various depreciation and escalation factors, such as variation of construction cost, Consumer Price Index (CPI) and so on. It forms the basis of the underwriting review of the insured’s risk and how this could be covered in terms of direct insurance and re-insurance cover.

The correct declared insured values ultimately determine the amount of coverage that the insurance policy will provide, come claims time. If the declared insured values are too low, the policy may not provide adequate coverage to protect the business fully in the event of a loss – resulting in underinsurance, where the insured technically co-insures for the shortfall. If the declared insured values are overstated, it does not suggest that the insurer will pay out the higher value, as they will only settle to the replacement value or loss limit, which results in higher premiums for coverage that is not needed in addition to higher loss limits than needed, which could influence the market’s risk appetite and rates.

“Having accurate declared insured values is fundamental to the insurer being able to properly underwrite the policy, assess the risk of insuring the business, determining the appropriate premium to charge and assessing the claims settlement amount in the event of a partial or total loss,” says Kent.  

Calculating Declared Values, Correctly

“Declared values are based on a complex calculation that works from a basis of the original cost, but then also needs to take factors such as the Consumer Price Index (CPI), Building Cost Index (BCI), Producer Price Index (PPI), Personal Consumption Expenditure (PCE) and Gross Domestic Product (GDP) into consideration,” Kent explains.

“When it comes to insuring a business, the process can be especially complex, so it is highly recommended to make use of a Professional Registered Valuator (PRV) who will consider all aspects of the client’s property and operations, including fixed and movable assets, to provide a professional overview of the calculatable risk exposures the client may be faced with when it comes to reinstating the business to the same condition/state it was in before an incident,” says Kent.

The basis of original cost, that all calculations are based on, can be calculated using two methods:

**NOTE: The option must be aligned to the indemnity requested by the risk carrier**

  1. Fair Market ValueFMV is the price that a property or asset would sell for on the open market, assuming that both buyer and seller are knowledgeable about the asset, are behaving in their own best interests, are free of undue pressure and are given a reasonable time for completing the transaction.
  1. Estimated New Replacement Value - ENRV is the replacement cost of an existing asset with a similar asset at today’s market prices. The asset in question can be a real estate property, investment security or account receivable. From a property point of view, the ENRV considers the catastrophic loss of a facility and includes:
  • Clearing and removal of rubble and waste,
  • Architectural design,
  • Professional fees including fire engineering, structural engineering, etc.
  • Local authority submission and approval
  • Preparation of site for reconstruction
  • Construction
  • Approval of construction

Aon offers a case study to illustrate the difference between these two calculation methods:

Case Study

Company A purchased an office facility in Gauteng and paid a total of R78,340,697 and all legal and incidental costs. The building was purchased for the purpose of utilising the first two floors as their new Head Office and sub-letting the remainder of the office space with the value accepted as a Fair Market Value (FMV), meaning it was considered as a reasonable purchase price.

When considering insurance options, Company A decided to have a professional valuation completed by a reputable and registered valuator. The Estimated New Replacement Value (ENRV) for the building was returned at R316,600,000 illustrating the difference between FMV and ENRV.

“If Company A decided to insure its property using FMV as the basis of calculation, the property would be under-insured by 75%. In such an event, the insurer will assume that you have elected to carry a portion of the risk yourself. As a result, you may find yourself in a situation where you are paid partially for a loss at claims stage due to the average formula being applied. It means that if your property is under-insured by 40% for example, then you may only be paid out for 60% of your claim, regardless of whether it is a partial or total loss. And while the client would have saved money in terms of premium expenditure, the under insurance would have a negative impact during the claims process,” Kent explains.

Example using figures from case study: If the client had an incident where a claim was lodged for R25,000,000 due to a fire at the premises of Company A, the claims calculation would be:

[R78,340,697 (FMV) ÷ R316,600,000 (ENRV)] x R25,000,000 (claim) = R6,186,094 (Claim pay-out value)

“As can be seen, the claim pay-out value of R6.1m is not sufficient to cover the loss that the business suffered of R25m; and is likely to have dire financial consequences for the business. If the declared insurance business interruption insured values are also incorrect, then the business would have unsustainable business interruption costs further impacting its ability to fully recover from the loss,” says Kent. 

It is imperative for clients to ensure that their declared insurance values are based on factual input that is evaluated regularly to obtain a certified valuation on business assets such as property, plant, equipment, furnishings, finishings, processes, transportation, warehousing and stock. Ensuring that the methodology used to calculate declared values is accurate provides the business with the necessary data and insights it needs to make decisions that are better informed on what the business needs to overcome adversity, at the time of claim,” says Kent.

“This is achieved by completing a comprehensive professional valuation on every building or at least conducting professional valuations on a rotational basis that ensure the comparative internal calculations are functional and within the scope of expectation. It is here where the input and insight of Aon’s independent risk consulting team proves invaluable in ensuring that your business submits accurate and current asset valuations and that any insurance claims settlement will see your business fully recover,” Kent concludes.

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