Buildings Sum Insured After a Renovation
A landlord insures a three-storey commercial building (ground-floor retail let to a tenant, two upper floors let as offices) under a commercial property policy with a buildings sum insured of €850,000, set three years ago. Since then the landlord has completed a €180,000 fit-out including a new roof, upgraded electrical systems and a rear extension. Rebuilding costs in the area have risen roughly 12% over the same period. The policy has an average (underinsurance) condition and a 90-day business interruption (BI) extension based on rental income of €72,000 a year. A small fire in the rear extension causes €95,000 of damage to the building and the retail tenant cannot trade for six weeks, withholding rent.
1. Explain how the average condition is likely to affect the buildings claim, showing the calculation logic.
Read the worked answer
The average condition reduces claims in proportion to underinsurance: payout = loss × (sum insured ÷ required sum insured), subject to the policy wording.
The declared sum insured of €850,000 is stale. The €180,000 fit-out and the rear extension added value that was never reflected, and rebuild costs rose ~12%. A defensible rebuild figure would be materially higher than €850,000 - for illustration, if the true reinstatement cost is now, say, €1.15m, the property is insured for roughly 74% of its value.
Applying average to the €95,000 loss: €95,000 × (850,000 ÷ 1,150,000) ≈ €70,200, leaving Tom's landlord to fund the shortfall of roughly €24,800 from his own resources. The exact figure depends on the insurer's assessed reinstatement value, but the principle is that the claim is scaled down because the sum insured was inadequate. The lesson is to revalue the property after any material alteration and at each renewal.
2. Assess the business interruption position and advise what the landlord should do.
Read the worked answer
The BI extension is based on rental income of €72,000 a year, i.e. about €6,000 a month. The retail tenant withholds rent for six weeks (about 1.5 months), a loss of roughly €9,000. That is within the 90-day indemnity period, so the BI extension should respond in principle.
However, two points need checking:
- Average may also apply to the BI sum insured if the declared rental income figure is understated relative to actual rent roll (e.g. if rents have risen). The landlord should confirm the declared BI figure matches current rental income.
- The BI extension is only as good as the buildings cover it sits under - if average reduces the buildings claim, the BI calculation should be reviewed separately but the same underinsurance discipline applies.
Action: notify the insurer promptly, evidence the lost rent (lease and rent statements), and immediately revalue both the buildings sum insured and the BI/rental figure at renewal to avoid repeat averaging.