Unpacking replacement cost valuation figures

In line with sectional title prescribed rules, the replacement cost valuation needs to be undertaken at least every three years. Usually, this involves updating the policy as soon as possible thereafter, either adjusting the buildings sum insured upwards or downwards.

In a previous blog, we explained inflation and touched on the way a policy is structured in terms of the escalations. For this blog, we use a typical valuation and then show how one would apply the figures.

The valuation summary received from the quantity surveyor / valuer is set out as follows:

Residential Sections 1,447 sqm 13,167,700
Common Areas   1,743,220
Sub-total   14,910,920
Demolition cost   873,500
Professional fees 12.50% 1,973,053
Sub-total   17,757,473
Escalation   2,109,400
Sub-total   19,866,873
Value Added Tax 15% 2,980,031
Replacement Cost   22,846,903

While the replacement cost is shown correctly as R22,846,903, it includes escalation for the period of reconstruction and redesign.

For insurance policy structuring purposes, we will first strip out this figure (remove R2,109,400) as we will add this back afterwards. This will, in effect, be taken from R17,757,473 + 15% VAT = R20,421,094. (sum insured pre-escalation). Then we add 10% for escalation during the period of insurance (R2,042,109).

After that, we add back R2,109,400 + 15% VAT = R2,425,810 (escalation for the period of reconstruction and redesign).

We thus instruct the brokers or insurer to insure as follows:

Sum Insured at inception date: R20,421,094

Escalation (period of insurance): R  2,042,109

Escalation (period of reconstruction and redesign): R  2,425,810

This way the replacement cost is split into the correct policy format.

On day one the sum insured is R20,421,094If the buildings are completely destroyed after 6 months (half of the insurance period).

Thus add 50% of R2,042,109 to the claimed R20,421,094 (6 months escalation). Then add R2,425,810 to the claim for inflation or escalation during the period of demolition, redesign and construction.

Set out this way, the insurance total claim is easily estimated depending on when the claim occurs.

If one incorrectly insures for R22,846,903, the insurer may add the escalation figures on top of the already escalated figure, thereby causing an extra 10% or so premium costs for no reason. (In other words, the body corporate should be paying full premium on R20,421,094 rather than R22,846,903). This may seem trivial on these amounts but add an extra zero to this equation and the difference in premium can be substantial.

The Schedule of Replacement Values (SRV) can now also now be more easily constructed. This fresh schedule of replacement values should be endorsed on the actual policy schedule as required in the prescribed rules.

This is a fairly simple procedure but again it validates working with an insurance advisor who understands sectional title and the valuation process well to assist with setting out the schedule of replacement values and structuring the policy correctly.

Author: Mike Addison

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