Double or quits?

All intermediaries have been faced with clients who need cover in a hurry for a new acquisition, but is it worth the gamble taking on this risk without doing the right analysis ? We look at a simple example of providing fire cover on a building.

We all have clients that spend extensive periods of time negotiating the purchase of assets and only think of insurance at the last minute. How familiar are the frantic phone calls at 16;30 on a Friday afternoon from motor dealers requiring 'proof of insurance' so your client can take delivery of a new vehicle ? While this example is certainly common, even providing the simplest cover, such as fire cover on a new building, without the right needs analysis, is a gamble.

Let's say you receive a call from your client, or the bank, to insure a building that the client has just purchased. You are requested to arrange fire insurance on a building for R10 million. Most intermediaries would arrange this immediately without any prior thought as to the implications of the request. "Please insure my building for R10 million" is such an easy request to comply with. Not so!

Adequate analysis

Asking questions in terms of FAIS to make sure you have complied with the needs analysis adequately is one thing, but have you read the Fire Section requirements to make sure that the client is adequately insured? Here are a few questions that the intermediary should ask before rushing off to arrange the cover;
1. How was the value of R10 million determined ?
2. What has not been included in the valuator's report ?
3. Is the value of R10 million inclusive of;
* professional fees
* demolition costs
* municipal plans scrutiny costs
* Value Added Tax ?
4. Assuming that the figure of R10 million is adequate, which is unlikely, it is valid on the valuation date. What will the valuation be in six or nine month's time ?
5. How long will it take to rebuild the building - six, nine or 12 months? The estimate must be reasonable considering the current industry conditions.

Considering the policy wording

So, what does all this have to do with the intermediary and the Fire Section of a commercial business insurance policy? Let's take each of the five questions above and apply the policy wording to the answers.

1. How has the value of R10 million been arrived at?

Most clients will either tell you that they purchased the property for R15 million, but the bank has valued the land at R5 million, so the building must therefore be valued at R10 million. Or the client will tell you that a professional valuator has reported the 'turnkey value' of the building and structures as R10 million. Either way, the client will be quite confident that R10 million cover is sufficient.

2. What has not been included in the valuator's report?

If a professional valuator has issued a valuation report, whether for the bank or the client, it is vital that this report be read and understood.

Most valuator's reports exclude the following;
* escalation in value beyond valuation date
* fees of all professional bodies
* municipal plans scrutiny fees
* Value Added Tax

3.Does the value of R10 million include the following ?

* Professional fees - if intermediaries read the policy wording, they would find that the policy requires the sum insured to be adequate to allow for an extra 15% to cater for the employment of professionals to assist with the rebuilding of any damage.
* Demolition costs - no one expects to have to demolish their building, but following a fire or bad storm claim, parts of the building, if not all of it, may have to be demolished. The policy does not mention any percentage, but it is advisable to allow for an extra 10% of the sum insured to cater for this risk.
* Municipal plans scrutiny costs - again the policy wording does not mention any percentage, but an extra 5% of the sum insured would not be amiss.
* Value Added Tax - VAT must be added to all policy sums insured, or limits, since all claim payments are regarded as 'income' to the insured.

So, taking the above into consideration, you will arrive at a minimum sum insured of R14.82 million.

4. What about a claim happening on day 360 of the policy year. Will the R14.82 million be adequate?

Since the policy must be adequate at the time of any claim, the sum insured must be projected to day 365, minimum. What is the anticipated building inflation rate for the next 12 months? Let's say 15%, which is close but not 100% correct. Adding 15% to the R14.82 million means the sum insured for day 365 must therefore be R17.04 million.

5. Over and above this, how long will it take to rebuild the building, 6, 9 or 12 months ?. With the building industry hard pressed to complete contracts in advance of the 2010 World Cup Soccer event, it is more reasonable to assume 12 months.

Remember that the policy wording allows Reinstatement Value Conditions with the resultant Average condition applying.

Let's say it will take 12 months to rebuild the building following a total loss or near total loss. Add another 15% (compounded) to R17.04 million, and now the sum insured must be R19.6 million - say R20 million, just to be on the safe side. Of course there are other factors to take into consideration, like the Public Authorities Requirement Clause, but more about those in a later edition, since they do not really affect the Sum Insured.

Keeping the premium down

Relative to questions 4 and 5, there is a clause in the Fire Section wording that will assist in keeping the premium down. The Escalator Clause can be used, but note that the inflation factor must be re-calculated every year and advised to the insurer accordingly. If this is not done the clause does not operate, although the insurer will unlikely reduce the premium for this clause. This is an insurer's software problem since few, if any, programmers have been told about the failure of confirming the Escalator Clause percentage(s).

Weighing up the odds

To do your job correctly in this example, you should tell the client that you would only arrange fire cover on the building for a value of R20 million - double the valuator or the bank's value.

Or alternatively decline to carry out the client's request. Client's do not like this alternative, so maybe you need to request your client to sign a document stating that they are not interested in the calculations made according to the five questions as detailed above and that despite your recommendations their instruction remains to insure the building for R10 million. Such a signed document must be obtained at each renewal, or you must convince the client of the correct method of insuring Fixed Assets. You should think twice before accepting any instructions. In this example it works out, in effect, to a case of double or quits. As an intermediary, it is hardly worth risking a PI claim or an investigation from the Ombuds office for the relatively small premium involved.

Of course, you must keep a record of all your discussions with the client and just to be double safe, confirm all the questions and the client's answers in writing to the client.