High inflation has contributed to soaring reconstruction costs in real estate. This inflation is intertwined with high demand, supply chain issues, labour shortages, and expensive energy. Indexation can help keeping sums insured aligned with actual replacement costs, preventing insurance payouts from failing to cover the full costs of a loss event.
The effect of indexation
Indexation (or index linking) is a percentage uplift which insurance buyers can apply to a building’s declared value. The figures are calculated by insurers and are mostly based on the Royal Institution of Chartered Surveyors’ (RICS’) Building Cost Information Service (BCIS). This takes into account cost tender prices, resource costs, and the consumer price index.
Indexation broadly acts as an inflation provision to ensure the sums insured do not move too far out of alignment with general inflationary increases. This is generally applied at the insurance renewal of the property.
Applying indexation at each renewal will help to prevent the insured value of the property gradually falling below the actual rebuild (or reinstatement) costs, seeking to ensure that the insurance payout covers the full cost in case of a claim. Without the application of indexation, the underinsurance risk increases with each renewal.
Over the previous couple of years, indexation rates have been higher than experienced in recent history, reflecting global economic conditions and inflationary pressures. Annual index linking figures breached 10% and, in some instances, reached as much as 19%. These increases are mirroring the impact of inflationary pressures on the cost of claims (opens a new window).
Variations between indexation figures
Indexation figures can vary between insurers. While the BCIS commonly acts as a basis, insurers may also take into consideration more specific indices that are published to track the movement in costs particularly relevant to the real estate or construction sectors. These may include for example the House Rebuild Cost Index for residential risks and the Tender Price Index for larger landlords. Interpretation of these variations can create differences between insurers’ figures.
It is important to highlight that it is ultimately up to the insured to decide if it is appropriate to apply indexation to the sums insured. However, real estate owners need to make sure that the figures on the policy reflect correct values.
The need for regular revaluations
The index linking figures provided by insurers are not property specific and can gradually move sums insured out of alignment with the true value. This becomes more noticeable as the difference compounds. Real estate owners should therefore consider undertaking a buildings reinstatement cost assessment (opens a new window) (BRCA or revaluation) every 3 years while applying indexation in the interim.
Lockton can help ensure that the indexation rate applied is appropriate and support with the administration and management of the revaluation. Lockton collaborates with RICS surveyors who can provide revaluations at competitive rates.
For further information, please access the Lockton Global Real Estate and Construction page (opens a new window), or contact:
Simon Kirkpatrick, Vice President Global Real Estate