Introduction

When you live in a block of flats, buildings insurance is one of the biggest costs covered by the service charge. It’s there to protect the block if something goes badly wrong – a fire, a flood, or major structural damage. But here’s the catch: if the building is under-insured, the whole block could be at risk, or in reality the people holding the responsibility to place the insurance are at risk. That’s because of something called the principle of averaging. In this blog, we’ll explain what under-insurance really means, how averaging works, and why getting the insurance figure right is so important for both leaseholders and management companies.

What dos under-insurance in buildings insurance?

Under-insurance happens when the sum insured – the amount the policy says the building is covered for – is lower than the true rebuild cost. This isn’t the same as the market value of the flats, it is the estimation of the actual cost it would take to rebuild the block if it were destroyed. If the figure is set too low, the insurer may not pay out the full cost of repairs after a claim.

What is the principal of claims averaging?

The principle of averaging means that if a building is under-insured, any claim payout is reduced in proportion to the level of under-insurance. For example, if the block is insured for only 70% of its true rebuild cost, the insurer may only pay 70% of any claim – even for a smaller repair. This rule is standard in insurance policies and is designed to stop policyholders from deliberately under-insuring to save money on premiums. By now, if you are still reading, you may understandably be worried about who would pick up the shortfall.

Why is under-insurance such a risk for service charges?

Under-insurance is such a risk for service charges because if a claim is reduced, the shortfall has to be covered somehow – and that usually means higher service charges. If the insurance payout doesn’t meet the cost of repairs, the extra costs fall back on the leaseholders through balancing charges. In extreme cases, this can mean very large unexpected bills for everyone in the block.

And, if the block burned down, the underinsured, perhaps a Freehold or Residents’ ManCo could be left with a shortfall that they need to collect from the members. But if the members refuse, directors could even face litigation for not arranging the insurance correctly.

The danger is even greater if under-insurance has been an ongoing issue for years. Old claims still fall under the averaging principle, which means leaseholders cannot go back and correct the payouts. There’s no easy fix for the past – but directors can protect the future. By commissioning a valuation now and setting the current policy accurately, they stop history repeating itself and keep both the building and leaseholders’ finances safe.

How can management companies avoid the problem of under-insurance?

The safest way is to arrange for regular professional valuations of the building’s rebuild cost. Insurance brokers and surveyors can provide a proper reinstatement valuation, making sure the sum insured is accurate. This doesn’t just protect against under-insurance – it also reassures leaseholders that the service charge is being managed responsibly.

The RICS (Royal Institution of Chartered Surveyors) in the 4th Edition of the Service Charge Code for Residential Management states insurance reinstatement cost valuations should be carried out regularly, in the 3rd Edition it recommended three yearly. Ultimately, building costs go up and down and the rebuilding cost of a property is the derived from the built area, type of construction and current construction prices.

What should leaseholders do if they're worried about under-insurance?

Leaseholders have the right to ask how the sum insured was set and whether a recent valuation has been done. If the figure seems low, they can raise it with the managing agent or directors. It’s always better to ask questions before a claim arises than to face the shock of a reduced payout later.