How the lack of an insurance valuation leads to averaging
The elected trustees of a body corporate have a fiduciary duty to ensure that the body corporate is adequately insured. This is underlined by Sectional Titles Schemes Management Act No. 8 of 2011, rule no. 23 which prescribes that “A body corporate must obtain a replacement valuation of all buildings and improvements that it must insure at least every three years and present such replacement valuation to the annual general meeting.”
Who will enforce this rule and ensure that the body corporate has sufficient cover?
It is important to consider that an insurance claim is subject to averaging by the insurer if the body corporate is found to be underinsured. Averaging means that the insurer utilises its right to reduce the claim payout in accordance with the rate of underinsurance.
For example: A kitchen fire causes considerable damage to one of the units and a claim for R400 000 is lodged with the insurance carrier. Such a claim - being relatively minor - should be settled quickly as the body corporate’s insurance cover is worth R15 million - right? Wrong.
The insurer normally starts off by assessing the merit of the claim. For this task, they appoint a loss adjustor to assess the damage and check if the body corporate has adequate cover. After inspecting the fire damage, the loss adjustor determines that the claim is justified but advises the insurance company to pay out only R300 000.
Why is this?
The answer is simple: The loss adjustor found that the true replacement cost of all units and common property areas adds up to R20 million, including demolition costs, rubble removal, professional fees and VAT. However, the body corporate is covered for only R15 million which means they are under-insured by 25%. For this reason, the claim is also reduced by 25% and the owner is left with a shortfall of R100 000.
In this case, the trustees failed to fulfill their fiduciary duty, therefore they can be held personally liable for the insurance shortfall suffered by the owner of the damaged unit.
By foregoing the legally required replacement cost valuation and simply escalating last year’s sum insured by 10% to save the body corporate the valuation fee of approximately R2 800, the trustees acted negligently and thereby – unknowingly - ceded their indemnity cover.
On the other hand, if the trustees produced a professional valuation as the basis for the sum insured of R15 million, the body corporate can reprimand the valuation provider about the shortfall in insurance payout.
Our next topic: What liability do you face as a trustee in the event of underinsurance?
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What the sectional title law says about valuations
In this blog we highlight the key information for bodies corporate in the Sectional Title Schemes Management Act (STSM) No. 8 of 2011, including what a sectional title valuation ideally should entail.
Escalation of Buildings Insurance
When an insurance policy is due for renewal, many financial advisors will recommend a fixed annual escalation rate of 10%, sometimes even 15%. Does this reflect reality? What if the original sum insured was incorrect to begin with?
Trustee liability in the event of underinsurance
When a body corporate member suffers a financial loss due to an averaged or refuted claim as a result of underinsurance, the member is likely to seek alternative ways to recover the shortfall.
Elected trustees have a fiduciary duty to ensure comprehensive insurance cover and the affected member may consider seeking legal recourse against the trustees.
Chain of responsibility
On their part, the trustees will refer the matter to the valuer, appointed to determine the estimated total replacement cost for insurance purposes. Should the valuer be unable to represent his valuation against the insurance company’s assessor, the matter will be brought to the attention of the valuer’s professional indemnity insurer who is liable for financial damage incurred by their client in performing his duty as a valuer.
Theoretially, the aggrieved body corporate member will have a good chance of recovering the amount by which they were short-paid due to underinsurance, provided that the last party in the liability line is adequately covered or has sufficient funds to reimburse the claimant.
However, the following scenarios will put this theory to the test:
Scenario 1: The appointed valuer holds insufficient professional indemnity cover or nothing at all.
In this case, the financially damaged homeowner can take the trustees to task for not ensuring that the valuer has adequate professional indemnity cover. At this point, the trustees may present the matter to their own indemnity insurance but their insurers may very well refute the claim if it can be proven that the trustees acted negligently. If so, the trustees will be held personally liable for the financial loss suffered by the body corporate member. This may result in prolonged and painful proceedings for all parties concerned.
Scenario 2: The trustees failed to obtain a professional valuation.
This will be an open-and-shut case as the law clearly prescribes that a valuation must be obtained at least every three years according to the Sectional Titles Schemes Management Act No. 8 of 2011, rule no. 23. In disobeying the law, the trustees have acted in bad faith and in gross negligence.
Therefore, it is imperative that portfolio managers educate the trustees on the legal aspects of body corporate insurance. They should also advise the trustees on the attributes to look for in a valuer and how to budget for a valuation. Moreover, the trustees must also demand such vital guidance from their managing agents.
Our next topic: How to budget for a valuation and how to compare valuer quotations.
How the lack of an insurance valuation leads to averaging
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.