Negating the average clause – what can insurers and brokers do?

How to negate the average clause in insurance

Gone are the days when the terms and conditions relating to the average clause can be consigned to the fine print. Buildings insurance remains near the top of the most complained about financial products or services, according to FOS data, (insert stat). Increasingly, this is a common reason for buildings insurance complaints, which are on the rise. Figures from the Financial Ombudsman Service (FOS) show there were 6,846 complaints, in total, in the last financial year (2023-24) – a 5.4% increase on the previous year.

And with the Financial Conduct Authority’s (FCA) Consumer Duty coming into force last year – which places greater emphasis on firms demonstrating they’re putting customers’ needs first – it’s clear the average clause is one stipulation that needs to be spelt out clearly on any contract between the insurer and insured. This is where both insurers and brokers can play a vital role in educating, and ultimately protecting, their clients from a case of underinsurance and triggering the activation of this clause.

Underinsurance and the average clause – how are they linked?

Underinsurance occurs when the insurance cover or sum insured (the maximum amount of money the insurer is obliged to pay in the event of a claim), is less than the value at risk. In other words, the amount of money the insurer offers isn’t enough to complete the repairs or replace what was damaged. From incorrect initial assessments to outdated documents that don’t include reliable, up-to-date calculations, there are many reasons why a reinstatement valuation could be too low. But even if the insured never issues a claim for a full rebuild on their property or portfolio, many consumers mistakenly believe they’ll be protected for smaller claims. However, the reality is that they still run the risk of receiving insufficient cover, as the average clause allows insurers to adjust their payouts in line with the level of underinsurance.

For example, a property may be insured for its market value (a common occurrence) at £400,000, when its actual reinstatement value is £800,000. If the building incurs £20,000 pounds worth of damage, the insurer is only obliged to pay out half the amount, as the full rebuild cost is underinsured by 50%.

This has been compounded by a harder market. Previously, when prices were relatively stable, insurers had more financial wriggle room to accommodate inaccuracies because inflationary pressures weren’t as extreme. But extreme fluctuating materials prices have led to the industry activating the average clause more regularly, in an era where they can’t afford to be more forgiving.

However, there are key pointers that insurers and brokers can support their clients to do, to prevent the average clause being activated.

What a difference a year makes

Complete an annual review using a desktop assessment or evaluation to ensure the data is up-to-date and that the original sum insured still provides enough cover. From day one, an insurance policy will be automatically updated for inflation; generally monthly if using the ABI/BCIS House Rebuilding Cost Index (HRCI), for the duration of the policy. However, the core models are also updated every year and this can result in divergency in the index-linked assessments. Therefore, it’s important to check the level of cover when renewing.

In recent years, the materials indexes have seen extreme fluctuations – in 2022, annual movement in reinforcement (concrete) peaked at 86%, while softwood carcassing and structural members peaked at 42%.

Get it covered

Ensure that customers know that cover extends to the complete rebuilding of all structures, fixtures and fittings, as well as outbuildings – for example, garages, offices, boundary walls and fences.  Any extensions or new or updated fixtures must also be included – for example, green technology such as solar panels or heat pumps. They’re particularly important to include in a reinstatement value, owing to their installation requires specialist skills that are vital for an underwriter to take into consideration during an evaluation.

No security blanket

Ensure that customers know the differences between the market value of the property and the reinstatement costs. Generally, market values are higher than reinstatement costs but the opposite is also true, especially in economically depressed areas or areas of low economic activity. Blanket cover doesn’t offer much security either as it covers them for total buildings losses of up to an agreed limit. Although this could be a significant sum, it’s unlikely to be enough to cover the increase in construction costs that it may have done, say, five years ago. The BCIS House Rebuilding Cost Calculator is another tool that insurers and brokers can highlight to their customers, as it gives an indication regarding whether this is enough cover for their requirements.

The link in the chain

Although it’s rises, and more recently falls, in the Consumer Price Index (CPI) that tend to hit the headlines, indexes show that inflation has had an even more adverse impact on the construction industry. Reduced productivity, disruption to trade routes, soaring energy prices, material shortages and increased contractors’ preliminaries have all contributed to peaks in materials indexes.

The majority of building insurance policies use index linking to adjust for inflation. Where a Day 1 Policy is not used, an allowance should be made to the rebuild cost estimate for the duration of the policy rebuilding period. However, in a Day 1 policy, the rebuild cost is assessed on the first day of the policy and the policy has a provision for regular allowance for inflation. But it’s important to check the policy is linked to an appropriate index for an appropriate period. There should also be provision for index-linking to continue after the loss has occurred, during the period needed for the demolition and re-design, as well as obtaining building regulations, planning approvals and tenders throughout the subsequent rebuild period.

An index that measures house rebuilding costs will offer clients the best protection against inflation.

You’re history

For most reinstatement assessments, there’s no substitute for obtaining a boots-on-the-ground, professional valuation or survey. This is more appropriate for buildings and homes that are listed or have special design features. Period features such as timber panelling, ornate brick and plasterwork ​can increase costs as – in the event of a rebuild – materials that most closely match the original are required. As with green technology, it’s these sorts of elements and features that can complicate calculating reinstatement values, as the appointment of highly sought after artisan skills such as masonry or thatching might cause delays to the reinstatement, which could drive up the costs further. There are no shortcuts with these types of buildings and, ‘as a custodian of a listed building’, Historic England will expect the owner to replace specific features that are as close to the original as possible.

Let’s get digital

With so many variables involved in calculating the correct reinstatement sum, it’s important for insurers and brokers to have access to tools that provide up-to-date, realistic rebuild cost estimates. Technological developments are making it easier to identify and monitor potential risks through platforms that provide frequent data updates on construction supply chain costs, labour rates and building materials. Aside from saving time and improving efficiency, these tools can help to ensure adequate cover, minimising the risk of underinsurance and the average clause being activated – a win-win for a market that needs to demonstrate it’s practising due diligence for its clients and customers.

Conclusion

The FCA Duty coming into force last year and the rise in buildings insurance complaints has put much more of an onus on the insurance industry demonstrating their due diligence to their customers. Brokers and insurers need to do all they can to ensure consumers have a solid understanding of how, and why, underinsurance could lead to the average clause being activated. In addition to this, the employment of digital tools, used on an annual basis, can also help the industry to ensure it’s got the most up-to-date, reliable information, which will help to mitigate the risk of underinsurance and reduce the likelihood of the average clause being used.

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