“This building must be worth a fortune” – someone says at the general meeting, and from that moment the conversation about the sum insured runs on the wrong track. In insurance, the market price tells you almost nothing: the policy is there to cover the cost of rebuilding the property, not its sale price. The difference between the two figures is not theory – when a claim comes, it turns into money.
- The market price tells you what the building would sell for – it includes the land, the neighbourhood, demand.
- The rebuild value tells you what it would cost to build the same building again – materials, labour, design, demolition.
- The sum insured has to be sized to the rebuild value: a figure based on the market price can be wrong in either direction.
What is in the market price – and what is not?
The market price is written by demand: it contains the value of the land, the standing of the neighbourhood, transport, schools, the view. All of them things a fire cannot destroy – the land is still there after the loss, and so is the neighbourhood. That is why insurance has no business with them. The reverse is true as well: the market price does not contain the cost of demolition and clearing the debris, of new design and permits, or the current level of construction labour costs – all items that matter a great deal in a rebuild.
What makes up the rebuild value?
The rebuild value answers a single question: what would it cost to build this house again in the same size and quality? Its elements are typically the cost of building materials and structures, labour, the building systems and specialist trades, design and permit costs, and the demolition and removal of debris that follow a loss. This figure moves together with construction prices – because of the price rises of recent years, the value of many buildings has drifted well away from the amount set earlier. So it is not a one-off number but one that needs maintaining: value maintenance.
What happens if the basis is wrong?
You can be wrong in two directions. If the amount is below the true rebuild value, the building is underinsured: when a claim comes, the insurer may apply proportional settlement – the rule is explained in the underinsurance article. If the amount is unjustifiably above the true value, the building pays a higher premium for nothing – the insurer settles the actual loss, not the rounded-up figure. So the goal is not “as much as possible” but the accurate number.
How do we get to a good figure?
In practice the rebuild value can be estimated from the building's base data – floor area, structure, fittings – and from unit construction costs; insurers use their own methodology for this, and for larger or unusual buildings a professional valuation may also be justified. The manager's most important job is not the calculation but good base data: accurate areas, and reporting refurbishments and extensions (solar panels, new building systems). The steps of sizing: sizing the sum insured.
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