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.
In figures: average building costs have increased by a mere 26.6% from November 2008 until today, however, many buildings policies without a professional valuation for a benchmark have seen escalations of 70 - 80% in the same period.
The cost of building typically comprises labour, materials, equipment, fuel and - of course - the contractor's profit margin. The cost cycles of these components rarely are in sync with one another, as each of them underlie different input factors. For example: one would expect fuel price hikes, power outages and labour market turbulences to cause building costs to increase, however, this effect could be diminished in a climate of low building confidence where contractors would be forced to reduce their profit margins.
For this reason, the historic analysis and short-term forecasting of building costs requires a scientific approach and complex algorithms have been devised and perfected over the past half-century, enabling market analysts to make fairly accurate predictions based on input factors such as supply and demand, raw material prices, manufacturing costs and political and economical developments.
While we strongly recommend that a physical replacement cost valuation be conducted at least every 3 - 4 years in order to warrant adequate insurance coverage on a building at all times, this may not be economically feasible for some property owners and the forecast year-on-year escalation rate indicated in a valuation report will provide useful guidance for the annual policy adjustments in-between valuations.