The increase in prices in the building materials market has caused a situation where commercial property owners are at risk of underinsurance. “As a rule, the sum insured is determined on the basis of cost at the time of construction, which means that for older buildings, the sums insured and the reinstatement values chosen by clients may differ several times over,” says Sandra Smirnova, Asset Insurance Product Manager at Seesam.

According to Statistics Estonia, the price of building materials increased by nearly 7% in the third quarter of 2021 compared with the previous quarter. However, when compared with the third quarter of 2020, prices have hiked as much as 17%. “Even though the availability of materials is now improving, the effects of the shortage will likely be felt in the market for quite a while longer, which increases the likelihood that many companies today will face the risk of underinsurance. Inflation and rising labour costs mean that even a contract signed just a year ago may be out of date if indemnity was settled on a fixed amount,” says Smirnova.

How does underinsurance develop?
Companies from different sectors can have very specific needs. According to Smirnova, all business clients are therefore subjected to the same principle: in the case of legal entities, it is the insurer’s responsibility to calculate the amount needed to insure the building and its contents, as the manager of the company is the expert when it comes to the specifics of their business. 

“At the same time, most companies renew contracts automatically and the amounts originally agreed on may no longer correspond to reality. Particular attention should be paid today to objects whose construction period dates back more than ten years – as a rule, in such cases, the sum insured is determined on the basis of the cost of construction at the time, but the current level of construction prices puts many of them at risk of underinsurance. Add to this the hike in prices in the construction sector, and the gap between construction prices widens further in a period-on-period comparison,” explains Smirnova.
According to the expert, the most striking examples of underinsurance concern situations where a fire or another tragic event has almost completely destroyed a building. “The insurance company will fully pay out the maximum amount provided for in the contract, but if the sums insured have not been updated, it could lead to a situation where the prices for the restoration of the property have increased by 15-20% in the meantime and the client will have to cover the resulting price difference,” notes Smirnova.

Should private clients be just as worried? 
“While it is very difficult for an insurer to assess the estimated value of various business-specific equipment, it is much easier to determine the value of residential property. Of course, every home is different, but for insurance they are pretty standard: living room with a sofa and TV, bedrooms, kitchen... In the case of residential property, we can predict with a fair degree of accuracy what a home of a certain size might include and what its reinstatement value might be,” says the expert.
“And that is why, in the case of private clients, the insurer is responsible for the cost of construction, because the contract usually states that the objective is the restoration of the property to its original condition,” says Smirnova, adding that this fundamental difference in the way insurance contracts are signed is also the reason why the risk of underinsurance primarily concerns companies.

How to prevent this issue?
Companies wishing to ensure the security of their property should review their existing insurance policies and make sure that the compensatory amount chosen is adequate in light of market developments. You do not have to wait until the end of the insurance period to do this. The sum assured can also be changed in the middle of the contract period!
“When determining the sum insured for both newer and older objects, it is important to take into consideration the up-to-date and realistic reinstatement value that would enable an equivalent building to be constructed in the event of total loss due to damage. Since the steep rise in construction prices started last year, insurance policies signed before 2020 may involve certain risks. To calculate the fair price, companies should calculate how much it would cost to restore the property today and also to take into consideration expected inflation over the contract period,” Smirnova advises.