The sums insured of homes and buildings, in general, should be reviewed by the insured every few years so that they are in line with the current residential or property construction costs, so as not to make, legitimately or not, one of the most common mistakes in the case of insurance that of underinsurance and be confronted with the condition of Average Clause.
Let’s consider a simple example to understand what constitutes underinsurance and the condition of an average clause. When you first bought and insured your home, it had a certain value. Most likely, your home at present is worth for a variety of reasons:
- Because the building construction costs in general have increased
- Because you have made additions, alterations, or repairs.
- Because you have enriched and enhanced your home
If the insurance of your home continues to have the same sum insured over the years, then most likely your insurance does not fully cover you. To check if this applies in your case, simply compare the sum insured of your insurance coverage with the current value of your home and its contents to see the difference. We also very often come across the term ‘underinsurance’ when the lender bank usually requires the borrower to insure the mortgaged property.
If the borrower has part of the capital required to purchase the property and borrows the remaining part of the total value, the bank requests that the property be insured for the loan, but this value does not correspond to the actual value of the home because it forms only part of the total actual value. This is how underinsurance is established.
Consequently, we should adjust the sum insured on our property every few years so that it reflects the current cost of rebuilding it.
But why is underinsurance a problem and how does the condition of average clause apply?
Underinsurance essentially means partial insurance and this in turn means partial compensation. For example, if a house with its contents is worth €60,000 and is insured for only €30,000, then the compensation is halved. As a result, if there is a loss of €20,000, then the amount that will be paid under the insurance policy is reduced to €10,000.
For that reason, is such a risk worth taking just to save a few more premiums? Certainly not!
Furthermore, it is worth referring to the usual definition of underinsurance given by the Insurance Companies, which was examined by the Cypriot Courts in the case of Stylianou Michalakis and Laiki Insurance Company Ltd (2012):
Average: If the property hereby insured shall, at the breaking out of any fire, be collective of greater value than the sum insured thereon, then the insured shall be considered his own insurer for the difference and shall bear a rateable proportion of the loss accordingly. Every item, if more than one of the policies shall be separately subject to this Condition.»
In plain terms:
Proportional Clause: If, at the outbreak of a fire, the insured property is collectively of a higher value than its insurance coverage, then the policyholder is deemed the insurer for the difference amount. The insured must bear a proportionate share of the loss. In essence, when the insured amount of a property (e.g., a building) is maintained below its actual value (as assessed at the time of the damage the policyholder is considered the insurer of their property. They shall assume the difference resulting from the application of the Proportional Clause, provided it is stipulated in the insurance policy.
For the subject under consideration, reference can be made to MacGillivray & Parkington on Insurance Law, 6th edition, paragraph 2000, p. 835 where the case of underinsurance and the existence of terms and conditions in the insurance contract known as “subject to average” or “condition of average” or “average clause” are dealt with. Below is a relevant excerpt:
I provide the relevant excerpt below:
«2000. It has therefore become the almost invariable practice for insurers to declare that the policy is “subject to average.” or “subject to the undermentioned condition of average” which means that, if the sum insured does not represent the value of the property insured at the time of the loss or damage, the insured is to be his insurer for the requisite proportion of the insurance and must therefore bear a part of the loss accordingly. In Carreras Ltd. v. Cunard Steamship Co. where the plaintiff company warehoused goods with the defendant company at a fixed rental to include insurance against loss or damage by fire, Bailhache J. held that the so-called pro-rata condition of average was so common in fire insurances on merchandise that is must be implied as a term of the warehouse agreement.
The average clause now occurs in almost all policies, except those relating to private dwelling-housed and household goods, and to a building and its contents used wholly or mainly for religious worship».
A similar term was considered in the case of EAC v. American Home Assurance Co. Ltd. etc. (2003) 1 A.A.D. 1570 which was as follows: “17. If the property hereby insured shall, at the breaking out of any fire be collectively of greater value than the sum insured thereon, then the insured shall be considered his own insurer for the difference and shall bear a rateable proportion of the loss accordingly. Every item, if more than one of the policies shall be separately subject to this condition.”
The Supreme Court, examining the above term in the light of the facts of the case, emphasised, among other things, the following: ‘’ ……… where it is established that the insured property is collective of greater value than the sum insured thereon, then the insured shall be considered as being his insurer for the difference and shall bear a proportionate share of the loss accordingly. The Court, regarding the E.R. Hardy Ivamy “General Principles of Insurance Law”, 4th ed., para. 538, defined the agreement as an Average Policy and consequently, in case of a partial loss of the insured items, the insured may not collect the entire amount of the loss within the limits specified in the agreement, but only such a proportion of it as the sum insured corresponds to the full value of the subject matter at that time.
A reference related to this issue is made in the book of MacGillivray & Parkington on Insurance Law, 6th ed., para. 2001. The conclusion reached by the first instance judge on the matter is that in similar cases, the insurer does not pay the full amount specified under the policy but part of it.
The amount payable is determined by multiplying the sum insured by the amount of the loss divided by the amount of the actual value of the goods at the time of the accident according to the following formula:
Claim amount= sum insured x amount of loss
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actual value of goods at the date of the accident
Example:
Full value of the building (as estimated) at the time of the damage: 200,000 euros. Sum insured: 100.000 euros. Repair costs: 50.000 euros. The formula used is as follows:
Claim amount= Sum insured at the time of the loss x Actual costs of repair
———————————————————————————
Full Value of the building at the date of the accident
That is:
100.000 Χ 50.000 = 25.000 euro
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200.000
Amount to be paid by the Insurance Company (Compensation): 25.000 euros.
Amount to be paid out of the insured’s pocket, due to underinsurance: 25.000 euros.
In the example, the insured kept the sum insured at 50% of the actual value of his asset, as estimated at the time of the loss. As a result, the compensation from the insurance company was reduced to 50% of the cost caused by the damage and consequently, the remaining 50% shall be borne by the insured himself as his insurer.
Having in mind this very essential term of the insurance policy, it means that the sum insured must always be within the context of the actual value of the asset to be insured. In cases where someone on his own free will underinsures an asset, possibly to save premiums, or through negligence or ignorance or failure to take proper professional advice he underinsures an item either by letting the sum insured remain the same for several years without proper adjustment or by declaring from the beginning a lower value. He should know that he is not fully covered and in the event of the occurrence of an insured peril, he will find himself to pay even if he has insurance cover in place ….
Construction cost 2020
Based on the data of the Statistical Service (BUILDING PERMITS FOR THE CONSTRUCTION OF NEW HOMES, BY AREA, VALUE, AND NUMBER OF DWELLING UNITS), the construction cost for 2019 for detached houses amounts to 1,235 euros per sq.m. which is the period before the start of the pandemic.
The year 2020 had several peculiarities (lockdown etc.). This cost must be adjusted to today’s data and therefore the 18% increase related to the increase in the domestic producer price index (materials, labour, and energy) should be considered (year 2019 vs 2022).
It is noted at this point that in the publication of the Statistical Service CONSTRUCTION AND HOUSING STATISTICS 2016, “it is commonly observed that in some cases, the estimated cost of constructing the project, as recorded in the building permit, was much lower compared to the actual value of completing the project.”
Therefore, considering the relatively recent requirements (from 2020 onwards), such as the homes now being required to have almost zero energy consumption, it can be estimated that the average construction cost for a typical single-family house today is around 1,700 euros per square meter (buildable area). This is confirmed by professionals in the market. The average construction cost for a typical apartment is estimated to be slightly lower.
Consequently, considering the relatively recent requirements (2020 onwards) such as dwelling houses that must now have to be of almost zero energy consumption, it can be estimated that the average construction cost for a typical single-family house today is close to 1,700 euros per sq.m (buildable area) something that market professionals also confirm.
The average construction cost for a typical apartment is estimated to be slightly lower.
Regarding the cost of buying a ready-to-deliver residential unit (house or apartment), it is noted that based on an analysis of recent sales of apartments (where the Sales Documents are deposited in the Department of Cadastre & Land Surveying) conducted by the Association of Cyprus Real Estate Appraisers, it appears that the average sale price is 2,650 euros per sq.m. buildable area. 102 sales in Nicosia, 94 sales in Larnaca, and 60 sales in Limassol were used. At the same time, the city of Paphos and the municipalities of the free Famagusta District due to the very small number of grocery stores, especially for new ones, were not considered.
It is noted that there are differences in the purchase price per square meter depending on the district where the residential unit is located. In this regard, there is a (not significant) differentiation depending on whether it is an apartment or a house.
Considering the increases in the Producer Price Index which affected the construction cost and consequently the purchase value, the purchase value of €2,650 per sq.m mentioned above can be considered a good indication of the average purchase price of a ready-to-deliver house/apartment considering a reasonable and average cost of land, licensing costs as well as a reasonable business profit.
However, we believe that this matter needs further study with the involvement of the Department of Cadaster & Land Surveying to draw more accurate conclusions.
QUICK TIPS:
- Ask for the advice of an experienced appraiser for the correct calculation of your Property Insurance.
- Reevaluate the insured property at regular intervals and review your insurance policy accordingly to ensure that you are adequately insured.
- Read the terms of your insurance policy very carefully. I will be happy to answer any questions you may have.
Important Note
This study has been prepared to provide a simple guide to interested parties and has been drawn from various insurance, legal, and other sources. It does not constitute a comprehensive or complete analysis of the legislation, nor does it constitute LEGAL advice. The views expressed are strictly those of the author and do not bind the company employing them.
Any errors that may exist are those of the author. Readers are encouraged to seek independent legal or insurance advice before applying the information contained in this study. For the current value of your property, it is recommended to consult a professional real estate appraiser.
Savvas Christoforou
CLU FLMI MBA LUTCF
Chartered Insurer
