Reducing Sums Insured can be costly

Given the recent economic downturn and decline in property values, many people are trying to save money by reducing how much they insure their house for, wrongly believing that they should insure for the market value. We therefore publish a summary of an article which was featured in our Summer 2009 Newsletter. You can view all previous editions of our newsletter by clicking here.

Insurance is designed to put you back into the same financial position after a loss that you enjoyed before the loss - either by repair or replacement. What someone is willing to pay for your house is irrelevant, you insure for the rebuilding cost i.e. the cost of rebuilding the property if it were completely destroyed (plus extras for demolition, debris removal, architects cost etc). Take the following example:

Property 1 is located in an area filled with celebrities homes, has stunning views of the coast and has a low crime rate.

Property 2 is identical to the property above however it is located in an inner city area, surrounded by empty shops and derelict houses and has one of the highest crime rates in the country.

The values of each property would be wildly different but they would still cost the same amount to rebuild and should therefore be insured for the same figure

If a property is underinsured i.e. the sum insured is not enough to rebuild the property, most insurers will apply the average clause which states "The insured acts as their own insurer for the difference between the actual value and the declared value". An example of this is a property which would cost £200,000 to rebuild (actual value) but is only insured for £100,000 (declared value). If there was a claim for £50,000, the insurer would only pay £25,000 as the policy holder is, in effect, acting as their own insurer for half the property. It works on small claims too, claim £1,000 and the insurer will only pay out £500.

The only accurate way to find out the correct figure you should insure your property for is to have a survey carried out by a member of the Royal Institute of Chartered Surveyors (RICS), alternatively the Building Cost Information Service (BCIS) of RICS, in association with the Association of British Insurers (ABI), has produced a rebuilding cost calculator which can be accessed at abi.bcis.co.uk.

The information contained above is provided for information purposes only, to inform you about developments which may be of interest. It should not be taken as authoritative or comprehensive view of the material concerned and does not constitute legal advice. Lyon Insurance Services Ltd does not accept liability for any loss or damage arising from the use of or reliance upon any information contained within this newsletter. Please seek appropriate legal or professional advice in relation to how the material may affect you.