Hidden costs that make up a sum insured

Sums insured are incredibly important when it comes to property insurances as getting it wrong can result in under-insurance and prove costly. But do you know just what needs to be considered when calculating a sum insured, asks EBM RentCover Managing Director Sharon Fox-Slater.

When it comes to property insurances like landlord cover, one of the things you may need to help your clients get on top of is nominating the sums insured. 

A quick refresher… The sum insured is the amount listed on the insurance policy as the most the policyholder can claim – that is, the most the insurer will pay – if an insured event leaves the policyholder needing to repair, replace or rebuild.

Ideally, it should be enough to cover the full cost to rebuild the home and/or replace contents. 

While some policies include standard sums insured components, say for example up to $70,000 for contents (as is the case in EBM RentCover Platinum and Ultra policies), there may be a need for the landlord to nominate a sum insured themselves – this is almost always the case for the building, but sometimes for contents too. 

When a landlord needs to nominate a sum insured, they need to work out what it would cost to replace the property and/or contents if something happens, like a fire, theft or storm damage.

As the sum insured is the maximum an insurer will pay out, the figure needs to be a true reflection of current replacement costs.

If it isn’t, the landlord is at risk of being under- or over-insured. Being under-insured means the landlord may not be paid out enough to cover the actual cost of their loss and would need to make up the shortfall out of their own pocket.

Being over-insured is simply a waste of money as they’ll be paying a higher premium than necessary as insurers will generally only pay out the actual cost of the loss regardless of the sum nominated.   

So, depending on the policy and the insurer, your landlords may need to nominate a sum insured for their building and/or their contents. And you may need to offer some guidance as to how they can go about working out an accurate sum insured.

Calculating sums insured

The idea of working out sums insured can be a bit daunting. It’s not as simple as making a rough guesstimate and hoping for the best – the consequences of getting it wrong can be financially devastating. 

Imagine if your landlords insured their rental for $500,000 only to suffer a total loss (for example, it burns to the ground during a fire) and discover that the actual replacement cost is $800,000.

Would they be able to find the extra $300,000 to rebuild?

And now imagine the fall-out if your landlords had asked for your guidance in working out the sums insured, and you led them astray.

In the current environment – high inflation, scarcity of raw materials, high costs for building materials and home goods such as appliances, skilled tradie shortages, high labour costs, supply chain disruptions, catastrophic weather events across the country that have wreaked widespread destruction – it’s more important than ever to get the sums insured right.

To ensure this, it’s really important to carefully review the sums insured at every renewal, as costs are rising rapidly and estimates can become out-of-date quickly.

Despite the imperative to get accurate pricing, many fall into the trap of using the wrong source to obtain a replacement cost.

The wrong sources include:

• purchase price – what the landlord paid for the property
• market value provided by an agent/valuer – what the property could sell for 
• rates valuation calculated by the local authority – the GRV (gross rental value) of the property 
• valuation provided by the bank – used to determine the LVR (loan-to-value ratio) in a home loan application. 

The sums insured need to be based on replacement value – that is, what it would cost to reinstate the property to the same standard (quality and specifications) or replace contents (on a new-for-old basis).

The most accurate costing can be obtained from a quantity surveyor. A builder, architect, valuer or other suitably qualified professional could also be engaged to provide an expert opinion.

While this is the way to get the most accurate estimate, it isn’t cheap and for many landlords it might be hard to justify the cost.

For landlords looking to do their own sums, there are numerous online building and contents calculators available.

The Insurance Council of Australia website provides links to the Cordell Sum Sure tool for building costs and to the Home Content Calculator for contents.

And, some insurers will have their own calculators, customised to their underwriting criteria. 

The building calculator will usually have basic property information pre-loaded based on the address, with the owner needing to confirm and add additional information about the premises (e.g. building materials, slope) to obtain an accurate rebuild costing. 

The contents calculator will also provide an estimate based on the address, with the owner needing to adjust the details to obtain a cost.

To assist with this, the landlord should make a room-by-room inventory of the contents (fittings and furnishings) they own at the rental (not their tenant’s possessions).

The ‘hidden costs’

The professionals and the calculators will provide estimates based on current building costs and replacement values.

But more goes into the calculation than just heading to the local hardware store to get some prices. Beyond the material and labour costs, there are also hidden costs that need to be factored in.

These extra costs, which may or may not form part of the estimate provided (landlords should always check exactly what has been included), include:

• Fees – the cost of site clearance/demolition, waste disposal, specialist disposal such as asbestos, development applications, building permits, architect’s fees, coordinating tradespeople and getting connections back on, all add to the rebuilding costs.
  
• Inflation – the CPI indicates how much more goods and services are costing and can add significantly to the cost of rebuilding or replacing goods. In recent years, the building industry has been hit hard by rising costs, with materials like steel skyrocketing more than 40 per cent last year alone. Inflation can erode the value of the sum insured, increasing the risk of under-insurance. Most insurers will automatically adjust the sum insured on renewal to take inflation into account, but it may not be enough to cover the true increase in costs. 

• Statutory upgrades – depending on when the property was built, the building standards may have changed, and upgrades may be required for the new building to comply with the national building code and local building regulations. This is especially the case in natural catastrophe prone or affected areas, such as those with a higher bushfire (BAL rating), flood or cyclone risk. Specific mitigation measures may need to be incorporated, many of which come at a higher cost.   

• Supply chain issues – a spate of natural disasters, the ongoing impact of COVID-19 and the war in the Ukraine are current issues impacting supply chains. As a result, there are shortages of materials and labour, increased delivery times, higher transportation costs and a general blow-out in costs and timeframes when it comes to reinstating property or contents. This extra time and cost need to be considered when looking at sums insured, as the longer it takes for work to be completed, the greater the risk of prices increasing in the interim.   

Having accurate sums insured is crucial to your landlords being properly protected with insurance.

Figuring out adequate sums is complex.

There are obvious costs to include (like building materials, trade wages or the cost of buying new appliances) but there are hidden costs too that need to be factored in.

If landlords seek your guidance on how to calculate the sums insured, point them in the direction of a quantity surveyor, recognised online calculator (one which uses an actual address not just a postcode) or refer them to their landlord insurance provider.