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Annual Escalation of Building Costs (Part 1)

In our previous blog post, we discussed the many considerations in play when estimating the replacement cost of a building for insurance purposes. Now let us look at how to adjust the assessed sum insured when it is time to renew the policy.

Many financial service providers recommend an average annual escalation rate of 10% - but does this reflect reality? What if the original sum insured was 50% undervalued to begin with?

Applying this method results in a compounded increase of the sum insured by 61% over 5 years and 159% over 10 years. Of course, this can be far from reality, as is demonstrated by the table and graph below. 

Using the figures published by the Bureau for Economic Research (BER), we have compiled a trend analysis for building costs in metropolitan Gauteng over a 5-year period spanning from Q4/2008 to Q4/2013, with quite astonishing results:

Annual Q4 Comparison of Building Costs in Gauteng

Q4/2008 - Q4/2009

- 7.56%

Q4/2009 - Q4/2010

- 2.20%

Q4/2010 - Q4/2011

+ 10.04%

Q4/2011 - Q4/2012

+ 5.23%

Q4/2012 - Q4/2013

+ 4.37%

It is important to note that there are fluctuations within each period and that a year-on-year Q2 comparison will produce entirely different figures, as can be seen in the graph below. Also, as suggested by BER statistics, the average relative building costs are approx. 10% higher in Durban and 15% higher in Cape Town than in Johannesburg.

Building Cost Index for Johannesburg & Pretoria (Q4/2008 - Q4/2013)

Description: D:\Downloads\Escalation of Building Costs for Johannesburg (2).jpg

The essence drawn from this study is that the 5-year escalation from Q5/2008 to Q4/2013 has been a mere 10% for Johannesburg and Pretoria.  

Does this mean that FSP's should rather apply an annual average escalation rate of 2.5% for policy renewals? The answer is most certainly not! As is evident from the graph above, the annual variance can fluctuate widely within an insurance period and therefore needs to be assessed regularly in order to have your clients' sums insured on par with the future trend of building costs. The major drivers of this trend are supply and demand, manufacturing costs, competition within the construction market and the state of the national economy.

Currently in South Africa, our currency is weak and economic growth is being stalled by ongoing electricity constraints and labour market issues, causing the local building industry to suffer from rising costs paired with low building confidence - can you foresee how this will affect the short-term development of building costs? 

How the lack of an insurance valuation leads to averaging

10/12/2017

Without an updated insurance valuation, you could find yourself being underinsured and facing averaging by your insurer. As a trustee, you have a fiduciary duty to obtain an updated insurance valuation to ensure adequate insurance cover.

Annual Escalation of Building Costs (Part 1)

8/11/2017

In our previous blog post, we discussed the many considerations in play when estimating the replacement cost of a building for insurance purposes. Now let us look at how to adjust the assessed sum insured when it is time to renew the policy.

 

Annual Escalation of Building Costs (Part 2)

8/11/2017

Part 1 of this blog post dealt with how due diligence must be applied when adjusting the sum insured on renewal of a building policy, else the property owner faces the risk of being either over- or underinsured. In the aftermath of the global economic crisis of 2008, building costs saw a negative development for some years, however, many building policies kept being escalated by the habitual 10% per annum.