Homeowners left exposed
Insurers are being urged to lift the figures they use to estimate rebuild costs when working out the "default" sum insured they offer homeowners, or many people risk not having enough money to replace their houses if disaster strikes.
Leading quantity surveyor Construction Cost Consultants has just completed a report that showed a wide gap between the per square metre default rebuild costs assumed by insurers and the actual cost of the rebuild as estimated by expert quantity surveyors.
Insurers must lift the per square metre rebuild cost figures they use or that gap would leave many grossly underinsured if disaster struck, said CCC general manager Gary Caulfield.
As many as three-quarters of people buying house insurance just accept the default sums calculated by insurers, and for homeowners with large mortgages, there's a risk they would find themselves in a negative equity trap should their home be destroyed by the likes of fire or natural disaster. Banks and other mortgage lenders have woken up to the fact this could pose a risk to the money they have lent, particularly to those with high loan-to-value ratios.
CCC studied rebuild estimates prepared for nearly 6800 homes of varying size and construction.
For homes estimated to cost $400,000 to $500,000 to rebuild, for example, CCC's report showed an average per-square-metre rebuild cost of just over $3530.
By contrast, insurers' square-metre rates used to calculate default sums for homeowners ranged from nearly half that at $1850 to $2300.
The issue concerns all home-owners, though, because there has been a great swap of risk in the insurance game.
The scale of the claims flowing from the Christchurch earthquakes came as a shock to reinsurers, who subsequently demanded a clearer view of the financial risk of insuring New Zealand homes.
Sum insured house insurance policies, where the policyholder has to nominate a maximum the insurer would have to pay them in the case of their home needing to be rebuilt, came in to replace total replacement policies. That switch meant homeowners now carry the risk of under or over-insuring their homes. The higher the amount they estimate their house is worth, the more premium they pay.
Policyholders have three main options when choosing their sum insured for house insurance.
They can accept the default sum suggested by their insurer - which insurers warn against. They can use insurers' online calculators to calculate a sum insured themselves, or they can go to a quantity surveyor and pay for a rebuild cost assessment.
But Caulfield said with so many people just accepting the default sums offered by the insurers, the big mortgage lenders had woken up to the business risk that a wide-area natural disaster like the Christchurch earthquakes posed.
In some cases, it is possible low sums insured could result in people having to build more modest homes worth less than the sums owners owed banks.
Six months ago, when CCC had meetings with the banks, it was with their marketing, insurance, and mortgage people, Caulfield said. Now it is with the banks' risk managers, worried about the adequacy of default sums.
Caulfield said: "This leaves all parties - the homeowner, the home loan lender and the insurer - exposed, and the insurers are
now telling us that they will be recalculating their square-metre rate to produce a higher default sum for customers from the first anniversary of the new guidelines on July 1, 2014."
He also predicted the big mortgage lenders would work harder to encourage borrowers to ensure they are adequately insured. The company is soon to announce a deal with one of the banks to make quantity surveyors available at cheaper rates. "Banks and insurers know that it's in their own interests to ensure that customers have comprehensive cover, and that the increase in premiums that will result from a higher default sum - unless the customer opts to lower the sum insured, which they are free to do - will be balanced by a more accurate degree of coverage in the event of loss," Caulfield said.
The Bankers Association said it understood some banks may be looking at working with valuation professionals to provide free home replacement valuations for customers.
Tim Grafton, chief executive of the Insurance Council of New Zealand, said changes to default sums were likely from July. "We wouldn't be surprised to see default sums rise when renewals come around to reflect building inflationary costs over the previous year, but it is a competitive market, so each insurer will make their own call on any adjustments," he said.
An IAG spokesman said its companies (AMI, State and NZI) would "not be arbitrarily lifting default sum insured amounts for home insurance policy renewals", but would increase default-sum insured quotes by just over 4 per cent to reflect building-cost rises.
He said: "Modelling does not suggest original calculations were inconsistent with the purpose of the default sum insured amount - which was to ensure existing homeowners were not left without any insurance cover following the change to sum-insured policies, but had a ‘backstop' to protect them."
But he warned: "We have worked hard to make it clear that the default sum is based on the often limited, and sometimes inaccurate information we have on individual homes and that it is important for each homeowner to consider whether that default amount, or some other amount is appropriate for their needs."
And he said there were risks to lifting the default per square metre estimates. "Raising default amounts beyond what we understand to be general rebuild cost estimates, including trending building-cost inflation rates, could result in an unjustifiable premium increase to homeowners when we know affordability is a major issue for some."
That could lead to people cancelling policies, he said.
Total rebuild cost estimate Average cost per square metre based on CCC's estimates.
Under $300,000 $2985
$1.1m -$1.2m $4386
Sunday Star Times