The average condition cuts every claim, not just a total loss, and the premium saved by a low declaration is not even the landlord's.
Under the average condition, an underinsured claim is paid in proportion to how far the building was insured: payout = loss × declared value ÷ true reinstatement cost. On an illustrative office with a true day-one reinstatement value of £35.1m declared at £28.0m, insured at 79.8 per cent, an £8.0m fire claim pays only £6.38m, leaving the landlord £1.62m short; a total loss leaves it £7.83m short.
Worked in full in The Real Estate Asset Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Building insurance sits with the asset manager in most multi-let and many single-let buildings: the landlord insures, recovers the premium from the tenants as insurance rent, and covenants to reinstate after damage. The sum insured is usually carried forward year to year from an old reinstatement cost assessment. The premium saved by a low figure belongs to the tenants; the shortfall on a claim belongs to the landlord.
| Input | Value |
|---|---|
| Rebuild cost at today's prices | 30.0 |
| Demolition and debris removal | 1.5 |
| Professional fees, % of rebuild | 12% |
| Declared value on the policy | 28.0 |
| Build cost inflation a year | 4.0% |
| Policy year / design and consents / rebuild period | 12 / 6 / 24 months |
| Day-one inflation uplift on the declared value | 30% |
| Partial loss: cost of repairing two fire-damaged floors | 8.0 |
The policy is on a day-one reinstatement basis: the landlord declares the cost of reinstatement at prices on the first day of the policy, and the insurer adds an inflation uplift, here 30 per cent, to cover price rises during the policy year and the rebuild. Average bites if the declared value is below the true day-one figure.
Fees = 30.0 × 12% = 3.6
Day-one reinstatement value = rebuild + demolition + fees = 30.0 + 1.5 + 3.6 = 35.1
Declared ÷ true = 28.0 ÷ 35.1 = 79.8%, an under-declaration of 20.2 per cent, or 7.1
Payout = loss × ratio = 8.0 × 79.8% = 6.38; shortfall 1.62
Excel: =Loss*MIN(1,Declared/DORV)
Average applies to every claim, not only to a total loss. A partial loss well inside the sum insured is still cut by a fifth, which surprises owners who assume that a sum insured larger than the claim means the claim is paid in full.
A rebuild is paid at the prices of the day the work is done. The midpoint of the rebuild falls 12 + 6 + 12 = 30 months after the policy starts, so the cost rises by 1.042.5 = 1.1030, a 10.3 per cent uplift, to 38.72.
Average: 38.72 × 79.8% = 30.88
Policy limit: declared × (1 + uplift) = 28.0 × 1.30 = 36.40
Payout = lower of the two = 30.88; shortfall 7.83
Declared correctly at 35.1, the limit would have been 45.63, covering the 38.72 rebuild with 6.91 of headroom, and average would not apply.
| Declared value | Average ratio | Partial loss paid | Shortfall | Total loss paid | Shortfall |
|---|---|---|---|---|---|
| 22.0 | 62.7% | 5.01 | 2.99 | 24.27 | 14.45 |
| 26.0 | 74.1% | 5.93 | 2.07 | 28.68 | 10.04 |
| 28.0 | 79.8% | 6.38 | 1.62 | 30.88 | 7.83 |
| 31.0 | 88.3% | 7.07 | 0.93 | 34.19 | 4.52 |
| 35.1 | 100.0% | 8.00 | 0.00 | 38.72 | 0.00 |
On a total loss the shortfall is the same 20.2 per cent, but of a rebuild cost already inflated to 38.72, so it is 7.83 rather than the 7.1 gap in the declaration. Against that, the premium saved by declaring 28.0 instead of 35.1, at an illustrative 0.10 per cent rate, is about £7,100 a year, and it is the tenants' money, recovered through the service charge or insurance rent. The landlord takes a seven-figure risk to save its tenants a four-figure sum.
The US equivalent. American commercial property policies use a coinsurance clause instead: payout = loss × insurance carried ÷ (coinsurance percentage × value). With an 80 per cent clause, 28.0 carried against 35.1 is 99.7 per cent of the required amount, so the partial loss would pay 7.98 before the deductible. The 80 per cent clause tolerates far more underinsurance than a day-one declaration does.
Payout = loss × min(1, declared ÷ true day-one reinstatement value), capped at the declared value plus the uplift. A 20.2 per cent under-declaration costs 1.62 on an 8.0 fire and 7.83 on a total loss. Put the reinstatement assessment in the asset business plan's annual checklist, next to the replacement reserve and the flood risk review. The plan itself, with the rent roll and the ten-year projection, is in the free workbook for this case.
Yes. Average scales every claim by the ratio of the declared value to the true reinstatement cost, whatever the size of the loss. On an illustrative building worth 35.1m to reinstate and declared at 28.0m, an 8.0m partial loss is paid at 79.8 per cent, 6.38m, even though the claim is far below the sum insured.
The insured declares the cost of reinstatement at prices on the first day of the policy, and the insurer adds an inflation uplift, chosen from the insurer's options, for price rises during the policy year and the rebuild. With a correct 35.1m declaration and a 30 per cent uplift the limit is 45.63m, enough for a rebuild costing 38.72m at the midpoint of construction.
The rebuild cost, demolition and debris removal, professional fees, irrecoverable VAT where it applies, and the extra cost of meeting planning conditions and current building regulations. In the illustrative case demolition of 1.5m and fees of 3.6m are the items an old assessment left out: indexing it from 26.0m gives 30.42m, still below the 35.1m true figure.
This article is one calculation from The Real Estate Asset Manager. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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