Your Obligation to take Insurance

Where there is a mortgage over the property

Where there is a mortgage over the property, which is the vast majority of situations, the lender requires, as part of the conditions of the loan, that the property is insured for its full reinstatement value with a reputable insurer covering all normal risks. Where you have a lender, some insurers will ask the details of the lender to be placed on the policy in which case you should provide the relevant information.

What is the "full reinstatement value"

The issue of the "full reinstatement value" is always a difficult one. The reinstatement value is not the same as the value of the property or the sum that you have paid if you are buying. Some examples will illustrate this well.

In any street in Scotland there may be two houses of a similar size and worth a similar amount on the market. Let's say they are both three-bedroom houses worth around £250,000. However, one of the properties was built in 2010 and the other was built in 1875. The property built in 2010 will almost certainly follow modern methods of building which means that the reinstatement cost is often less than the value of the property on the market. On the other hand, the property that was built in 1875 might have a reinstatement value that might be as much as double the value of the property. This is because the 1875 house was erected using "handbuilt" methods particularly in relation to the stone construction and slated roofs. In the disaster scenario of the 1875 property being destroyed by fire or otherwise, there may be a requirement from the local authority that it is reinstated in it's "Original Form". This will particularly be the case if the property is listed or in a conservation area.

At this point, you may pose the question of the downside of insuring the 1875 property for its current value on the market as against its reinstatement value saving a good deal of cash. Good question! The problem is that insurers are well aware of this possibility and it has been the law for some very considerable time that the insurers can apply the concept of "average". What this means is that if there is a claim on the insurance policy and the insurers find that the property has been under insured in terms of its reinstatement value, then the amount that will be paid by them is reduced so that it is equivalent to the proportion that the actual insurance cover bears to the reinstatement value.

A quick example will help. Our 1875 property has a reinstatement value of £400,000 and a market value of £250,000. The owner of the property Insures it for £250,000 and sadly the property is impacted by fire with the cost of the necessary repairs estimated at £100,000. When the insurance company are asked to compensate the owner for the value of the repairs they will only pay £62,500 because that is the equivalent proportion of £100,000 that £250,000 is of £400,000.

Understanding insurance

Many people fall foul of this important point. Insurance is a contract which forms part of a group of special contracts called "fiduciary contracts". This means that the insurer is relying upon your good faith. If you confirm something in the insurance application process that is not true or you withhold facts such as the existence of history of flooding then you may invalidate the insurance.

McVey and Murricane are not regulated to advise you on insurance and you should ensure that you should channel any queries that you have to either your broker, if they are arranging the insurance or the insurer if you are dealing with the insurance company directly.