purpose of this article is to assist Members to understand the
essential elements of managing insurance programs in relation to
existing buildings by broadly outlining issues relating to the
insurance environment and risk management.
guidance note applies to Members who are called upon to advise
clients in matters pertaining to the insurance of their properties
and, in some cases, arrange the relevant insurances on their behalf.
It deals with the management of risk and protection from risk using
Insurance as an important element in achieving these objectives.
note deals with:
general background to insurance;
aspects of risk
relevant classes of
Not Technical Advice
guidance note does not seek to provide technical advice on specific
Beyond the Scope
issues associated with insurances for new construction or major
refurbishment projects are beyond the scope of this guidance note.
Members will need to be aware of these types of insurance from other
a guidance note of this nature can address the broad issues, it
cannot be definitive and you are, therefore, urged to consult with
the insurer, an insurance broker or your legal adviser to discuss any
aspects requiring clarification or expansion.
paper was produced by the Australian Property Institute to provide
general information, in summary form to its Members. The contents do
not constitute legal advice and should not be relied on as such.
Formal legal/insurance advice should be sought in particular matters.
2.1 Protect From
Risk of Loss Since the beginning of commerce and trade, humankind has
sought to protect itself from the risk of loss, be that loss associated
with property (real or personal), life or the ability to provide food
and shelter for the individual, family or community.
Convey Risk to Another
need to convey the risk of loss to another party has seen the
development of a number of risk transfer mechanisms, the most notable
probably being the concept of insurance.
Insurance is a Contract
is a contract between two parties where, for a consideration
(premium), one party agrees to pay for a stipulated loss suffered by
the other party. The payment of the claim simply fulfils the
Risk Transfer and Risk Combination
at the heart of insurance is the principle of both risk transfer and
risk combination. Risk combination allows the risk to be spread,
usually via an insurance fund, over a very large number of
individuals or corporate entities.
combination of many potential risks into a common pool or fund allows
the law of averages of large numbers to operate to the benefit of the
unfortunate few who suffer loss.
Statistical Data to Predict
a large number of homogenous items (be they motor vehicles, lives,
units or real property, etc) grouped together, it is possible from
statistical data to predict within reasonable limits the number and
cost of losses that will occur within the group. With this knowledge
can be calculated that are needed to pay the losses and the expenses
of operating the fund and to provide an acceptable profit.
Offer Long Term Security
that the insurance fund is able to offer long term security to its
policy holders, premiums must be sufficient to enable it to meet both
immediate claims and those that arise well into the future. The
fund’s long term viability is also dependent upon the level of
generated, operating expense levels and the sum of returns paid to
investors (be those investors shareholders or owners in a mutual
premium rates are determined by many complex factors, most of which
are outside the direct control of the purchasers of the insurance
protection, property owners can, however, take some actions that will
affect the premium they are required to pay.
Modern Risk Management Practices
risk management practices, careful analysis of the risks to be
covered, and the level of the risk that the property owner will
retain, are but a few of the factors that will determine the amount
of money that will be spent on loss prevention and insurance
paper deals with some of the insurance issues that face Members in
their management and development of real property.
General Insurance Environment
Premium Rates Fluctuate
rates available to companies and individuals seeking the protection
of insurance fluctuate in accordance with both local and
international insurance market conditions, the level of natural and
man made disasters (ie. claims), the economic climate and business
Management of Insurance Programs
management of insurance programs has thus taken on an increased
importance for professionals involved in producing satisfactory
returns from property investments.
the development during the 1980s of very large property assets which
in themselves require insurance cover of many hundreds of millions of
dollars, the amount spent on property insurance has become very
significant, both in aggregate terms and as a cost of operating
is necessary because it offers:
security to lenders
and other stakeholders;
comfort to customers;
business operations; and
employees’ jobs (ie. financial protection following a loss).
Insurance Costs Controlled
ensure that insurance costs are controlled, it is important that
owners and their asset managers are able to demonstrate to
underwriters the qualities of their buildings and management controls
is best done by risk management and ‘anticipation of risk, rather
than by reaction to loss.’
this is observed, it will not only assist all property owners to
control their risk but also their premiums.
Risk Management Responsibility of Officers and Directors to Owners
Some Have a Legal Obligation
effective risk management procedures is not simply a matter of good
management, some people have a legal obligation to their employer.
officers and directors of a business have a legal responsibility for
the proper management of pure risks.
risk is the loss of, or damage to, property or injury or death of
persons using the property. It can be accidental or fortuitous,
foreseen or unforeseen. They have an overall legal duty and a
specific obligation to use care and be diligent in the administration
of the affairs of the corporation and in the use and preservation of
that the failure to effect proper insurance coverage, to pay premiums
when due, or to keep coverage in force, may well be the basis for
personal liability suits against the officers or directors of a
business. The legal standard of performance is that officers and
directors must exercise the care that an ordinary prudent person
would exercise under similar circumstances.
Process to Identify and Quantify Exposures
Management of Real Property is the process through which an
organisation can identify and quantify its exposures to loss, access
priorities and develop strategies to avoid losses or, if they do
occur, deal with them effectively.
benefits of the Risk Management approach are:
prior recognition of
real risks to an organisation;
helps Avoid or
reduced Cost of Risk;
conforms with Best
better Management of
Management has one objective; i.e. to ensure the economic continuity
of the goods and services of an organisation whilst minimising the
costs of both expected and unexpected losses. The activities of the
Risk Manager are influenced by the Owner’s general insurance
philosophy which can be summarised:
or reduce as far as practicable the conditions and practices may
cause insured or uninsured losses’.
non-core functions or inappropriate activities;
contractual liability of consequences, eg. tenants take public
liability risk; insurance and/or indemnity is required of contractors
working on site or supplying services or goods;
- imposition of
insurance, indemnity and hold harmless conditions in agreement with
- when premises
are rented risks may be transferred from owners to tenants or from
tenants to owners, depending on the lease conditions.
- The extent of
elimination or reduction affects insurance costs;
- When risk
cannot be eliminated or reduced to workable levels;
commercial insurance that will provide indemnity for catastrophic
- Either insure
or assume those risks not considered to be of major importance to the
operating or financial position of the Owner.
Importance and Complexity
risk management function continues to grow in importance and
complexity. Management is becoming more cost conscious and more aware
of how sound risk management helps to minimise expenses.
this reason, it is always important to have a risk management
strategy which can protect tenants as well as the owner and also
assist by demonstrating to insurers that the business is aware of
potential exposures and is implementing procedures to ensure such
exposures are controlled. This will benefit all parties and lead to
Identifies & Controls Potential Loss
risk management process identifies and controls potential loss
situations which can affect an organisation’s financial security,
reputation and viability.
order to identify the risks, it is important for the owner of the
property to be aware of potential hazards and to implement a control
to enable management to always be conscious of changes in tenants and
procedure should include risk identification, risk management and
Specific Risks – Risk Identification Process Systematically and
is the process by which a business systematically and continuously
identifies property, liability and personnel exposures as soon as
they emerge. Unless these risks are identified, all potential losses
will unconsciously be retained by the company.
Risks Easily Recognised
risks are easily recognised, and would be known within an
organisation.These should be identified by either the insurance
broker or the ownership entity, after discussions with staff and
staff should be given on-going support from Management in the
identification of risk.
risks shown below are normal within the property industry, and it is
in order to insure against perils such as these that an insurance
policy is purchased:
Storm and Tempest
Flood (not readily
available in flood prone areas)
(including loss of rent)
removal of debris
Impact by Vehicles or
Legal liability to
Compensation (compulsory) called
in some States
Motor Vehicle (Third
Party injury insurance is compulsory).
directors and offices arising out of a
(principal controlled contractor’s
to identify all the potential losses, a check list of all assets of
the company should be drafted, and a systematic approach used to
discover which of the potential losses provide the most exposure to
the company. This is best done internally by the person whose
responsibility it is to control insurance, or can be carried out by
firm, such as a broker/risk management company. Any independent firm
should work in liaison with the firm’s internal risk Manager when
conducting a risk identification survey.
each property is unique, both as to its operation, usage, location,
construction and cash flow pattern, it is important that a risk
profile be developed for each property, ie. Pro-forma profiles may
overlook some feature unique to a particular property.
Will Correctly Inform
this is a time consuming exercise, it is the only means which will
correctly inform the company of the risks/exposures it carries, and
which can be insured, therefore the exposure is transferred from the
company to an insurer;
where the exposure
cannot be insured, management controls can be implemented which will
diminish the risk to the company.
should be prioritised by analysing both the probable frequency of an
occurrence and the impact (ie. severity) on the company. Risks that
are assessed as having a high likelihood (ie. frequency), together
with a high impact, should be fully insured.
starting point is the excess under the policy. This indicates the
level of risk the company can absorb.
the risk has been identified, the potential losses must be measured
in order to determine their relative importance.
Replacement/reinstatement costs do not necessarily equal market
values should be calculated periodically by consulting professionals
who will assess the dollar value at risk to ensure,
the time of a major loss, the value of both property (ie. physical
structures excluding land value) and business interruption is
adequately insured. This will ensure that the business does not need
to fund part of the loss, which could impact on the viability of the
organisation. Extra costs
may be incurred if regulatory changes are triggered.
Surveyor and Valuer
quantity surveyor can be used to establish replacement cost
estimates for commercial buildings and a valuer for domestic buildings.
It is generally believed studies reveal that a significant
number of buildings are underinsured. The impact of averaging
insurance [GN 22: 9.5] means that exposure previously thought to be
insured is now only partially so.
risk management engineering surveys can be engaged to identify
specific, or peculiar exposures at each location.
physical survey, implemented by both management or a risk management
consultant, should include a review of:
for fire hazards and other exposures
extra costs are referred to later in this guidance note.
recording is a vital step in the risk management process.
an organisation does not record all losses, it is unable to take an
informed decision to carry a risk, ie. higher deductibles, which can
Risk Control Elimination or Minimisation
aim of risk control is elimination or minimisation.
risks are identified, practical and cost effective recommendations
can be made regarding the physical protection of assets.
all losses are monitored and investigated, the organisation is in a
position to take effective measures to either eliminate or reduce
organisation is well placed to effectively contribute
risk control due to their familiarity with the property.
supervision is also an aspect of risk control and a procedure should
be implemented whereby there is regular liaison with tenants to
ensure that their standards, or physical protection and housekeeping,
are in line with that provided in common areas.
these controls are achieved, the risk of losses is minimised, which
significantly influences premiums.
Risk Financing, Risk Transfer and Insurance
Total Cost of Risk
Total Cost of Risk includes such items as:
on fire protection and security equipment;
electrical and mechanical plant;
excesses or deductibles;
way in which the Total Cost of Risk is absorbed or otherwise paid for
can be referred to as Risk Financing.
Transfer of the operational or financial consequences of an event can
be effected in several ways, eg:
in Lease Agreements that tenants effect Glass and Public Liability
amount of the policy excess can be greater than the value of the
insurance will generally be restricted to the tenant’s operations
unless that tenant is the sole occupant;
Policies should be in
the joint names of the Lessor and Lessee;
Lessor may effect
insurance if Lessee fails to insure;
should reflect Lessor’s requirements.
with service providers to include insurance, indemnity and hold
harmless provisions in favour of the owner.
of insurance, ie. transferring the ultimate risk to an insurance
company per medium of effecting an insurance policy or policies.
Types of Insurance
Type of Policy Depends on Value
types of policy or policies of insurance to be effected will to some
extent depend on the value of the property.
criteria as to which insurances are appropriate for a given property
vary from insurer to insurer but as a general rule:
values less than, say, $1-2,000,000 and perhaps up to $5,000,000 will
be insured under Business Insurance or similarly titled package
values greater than these amounts will generally be insured under
individual policies for each category of risk to be covered.
Insurance policies generally offer a range of cover choices and those
most relevant to the insurance of property are likely to be as
explosion and other specified perils to cover physical loss or damage
to the property caused by those nominated perils;
i.e. loss of gross rentals and increased costs of work arising as a
result of a peril insured by the preceding section;
electrical and mechanical plant and machinery and consequential
losses arising there from; and
i.e. legal liability in respect of claims by third parties for
personal injury or death or damage to property arising out of an
occurrence in connection with the ownership or occupancy of the
7.3 Separate Policies for Higher Value Property
kind of separate insurance policies likely to be effected in the case
of a higher value property are as follows:
Risks (ISR) which insures ‘Physical loss or damage (and
consequential losses arising there from) not otherwise excluded’ -
the ISR policy therefore combines and expands upon the first two
elements of the Business Insurance policy as above;
electrical and mechanical plant and machinery and consequential
losses arising there from (which are exclusions under the standard
ISR policy); and
i.e. legal liability in respect of claims by third parties for
personal injury or death or damage to property arising out of an
occurrence in connection with the ownership or occupancy of the
addition to industrial special risks (ISR) policies on a full
reinstatement basis, other specific policies in relation to property
can be adopted to suit specific requirements or specific loss
categories. The requirement for these will vary according to
individual circumstances. These polices include:
loss of master key
insurance as an addition to conventional contract to cover such works
as tenancy fit outs or refurbishments.
i.e. misappropriation of money or goods by employees;
i.e. bad debts following tenant insolvency;
other appropriate insurance.
requirement for Workers Compensation insurance differs from State to
State and Territory to Territory.
must be exercised to ensure that, if there are any employees, the
appropriate insurance or statutory arrangement is put into place.
Issues to Consider in Choosing Insurance Cover
Assessing a Building’s Risk
main criteria for an insurer when assessing a building’s risk is:
materials used in the construction of the building;
ordinances. For obvious reasons insurers will not provide competitive
quotations where a site does not comply with ordinances as the
insurer would postulate that the lack of compliance would increase
fire Protection, eg.
sprinklers, are always an advantage, as it assists with minimising
the risk for insurers and, hence, results in lower premiums;
tenancy of buildings.
Insurers will always assess the exposure of tenants and quote
accordingly, eg. a mechanic is a higher exposure than a bank – this
will be reflected in the premium;
environment - eg. explosives/chemical plant, bushland, etc;
limitation of road
location of premises
(eg. on an existing flood plain);
ordinances eg. asbestos contamination (authorised removal is required
following an asbestos audit).
Comments at the Planning Stage
major insurance brokers and insurance companies are able to provide
comments on building design, fire protection and security. Ideally
this should be provided at the planning stages, but later if need be.
They will also be able to advise on risk management techniques
tailored to the individual property.
Three Basic Functions
core insurance program as discussed fulfils three basic functions for
a property owner/manager:
conservation of all
assets (Property insurance);
income/profits (Consequential loss);
liabilities (Public liability);
extent to which insurance fulfils these functions is subject to the
terms, conditions and exclusions of the policy, e.g.
generally a liability
policy will only cover sudden and accidental pollution;
asbestos is generally
an exclusion unless it is in static form.
Extensions to Policies
the above into consideration, there are some extensions to Business
Insurance and ISR policies which should be compulsory to any prudent
property owner. These are:
indemnity period should be long enough to provide for the following
in the event of destruction (e.g. by fire):
Removal of Debris
of debris. At times, the local council tip will not be able to handle
all the debris from a building due to either the content (asbestos)
or due to the bulk. This may incur very large charges/costs where the
debris may need to be removed by specialists and sent to a processing
which will accept the waste. Always ensure that the insurance limit
will adequately reflect the cost of disposal.
a rule 10% of the value of the asset would be a minimum but this
varies dramatically depending on factors such as the height and
construction of the building. (Note: Removal of asbestos has
extraordinary cost implications and may involve 50-100% of the value
of a building).
Reinstatement and Replacement
ensure that the policy provides for reinstatement and replacement
conditions - including the ability to rebuild on the site where
development controls may have changed.
policy should include the extra costs of reinstatement, which is the
extra costs incurred to comply with any requirement of any Act of
Parliament or Regulation, By-Law or Regulation of any Municipal or
other Statutory Authority.
Increases in Cost of Working
in the costs of working, which covers any reasonable expenses
incurred in order to minimise any long-term effect of a loss on
profit/revenue, eg. Overtime wages, the costs of leasing other
premises, including fees, advertising and promotional expenses.
insurance - to cover damage to property caused by flooding. This may
be provided subject to strict underwriting guidelines.
policies will be subject to an excess or deductible, i.e. the amount
of each loss which must be met by the insured following a claim.
Excess will Vary
amount of the excess or deductible will vary from insurer to insurer
and the nature of the property being insured.
Can Elect Higher Excess
owners can elect to assume higher excess or deductible than that
being imposed by the insurer although it is recommended that this
only be entertained where the insurer is prepared to offer a
substantial premium discount in return.
Exclusions: All insurance policies contain exclusions and it is
important that owners/managers familiarise themselves with those
exclusions applicable to their own policies.
The Importance of Valuations and Insurance
the context of insuring property it is important to be cognisant of
the definitions which apply to the various types of policy.
Insurance policies generally require separate sums insured to be
architects and professional fees (the term ‘Buildings’ is
understood to include the structure itself together with fixed
electrical and mechanical plant, sprinkler and fire alarm systems and
landlord’s fixtures and fittings);
contents - in this
regard the insurer should be asked to advise if carpeting and floor
coverings, for example, would be considered as part of the building
or would require a separate sum insured;
Costs of demolition
and removal of debris.
ISR Policy Covers
ISR policy covers 'all real and personal property of every
description’ under a single declared value for each property. Care
should however be taken to ensure that the value declared takes all
the above items into account.
value of land is not to be included in either case.
Insurance and ISR Insurance are quite different in the way they deal
with under-insurance and, irrespective of which policies operate for
a particular property or portfolio, care will need to be taken in
assessing the sums insured or limit of liability as applicable.
Generally properties are insured for their replacement cost and the
following aspects should be taken into account.
sum insured under Business Insurance is the insurer’s limit of
liability in the event of loss or damage. It is therefore necessary
to project the sum insured nominated at the commencement of the
policy period to cater for inflation and other cost variables during
the policy period.
ISR policy does not contain a sum insured per se but has:
Value, ie. the estimated value of the property
at the commencement of the period of insurance - as well as being
relevant to the test of coinsurance or average, this amount is
utilised for the purpose of premium calculation; and
of Liability, ie. the maximum liability of the insurer in the event
of loss or damage - this need not and should not be the same as the
declared value but should represent what the replacement value of the
property would be if, for example, it was totally destroyed on the
last day of the period of insurance. (Sub-limits are also generally
applied to contingencies such as accidental damage, burglary and
demolition/removal of debris costs).
both Business Insurance and ISR Insurance contain Coinsurance or
Average clauses which permit the insurer to reduce the amount of loss
Insured at the time of loss or damage in the case of Business
Declared Value at the
commencement of the period of insurance in the case of ISR Insurance.
less than 100%, 90%, 85% or some other specified percentage depending
on the insurer’s policy wording and/or the value of property
that there was a 100% Coinsurance or Average Clause in the policy,
the following example demonstrates how under-insurance can reduce the
amount of a claim.
x A = Claimable Amount P
= the sum insured or declared value in the policy
= the amount of the loss
= the correct value of all property
= $ 50,000
x $100,000 = $ 25,000 (Claim settlement) = $200,000
has occurred because, in this example, only 25% of the values were
selected as either the sum insured or declared value as applicable.
Note that the equation would vary in the case of, for example, a 90%
or 85% Coinsurance or Average Clause although the underlying
principles are the same.
best way of ensuring that a property is fully insured is to have the
property valued and the policy figure updated on a regular basis. The
valuer should be instructed to prepare the valuation so that the
valuation accords precisely with the basis of insurance eg.
Reinstatement, replacement and extra costs insurance or indemnity
value as applicable and include costs of demolition and removal of
debris and professional fees. At the very least, if a professional
not to be utilised, it is recommended that reference publications
such as Rawlinsons Australian Construction Handbook or Cordells be
Insured or Declared Value for Consequential Loss It is similarly
important to direct considerable attention towards assessment of the
sum insured or declared value for Consequential Loss insurance -
generally thought of as Loss of Rents insurance in the context of the
insurance of property. This insurance is also subject to coinsurance
is also possible to seek insurance cover on an indemnity basis being
either the market value of the building less the land value or the
depreciated value of the property. This can, under certain
circumstances, provide greater flexibility in the event of a
catastrophic loss but may lead to complications in regard to a
Levels of Insurance Within One Complex
should also be noted that different levels of insurance cover can be
taken for structures within one property complex but at different
levels of risk, eg. a factory and its outbuildings on the same site
where the factory might be under reinstatement conditions, and the
for their indemnity values.
Liability insurance is subject to a limit of liability for any one
occurrence ie. the maximum amount the insurer will pay for all claims
arising out of the one event. This means that the limit of liability
sufficient to cover all claims from all claimants arising out of the
injuries can take several years to stabilise to the point where some
claims can be taken to Court - there can be both inflation and
escalation in the amounts of damages awarded in the intervening
take account of the
possibility that at least some of the potential claimants will be
juveniles and that claims in respect of such persons cannot be
finalised until a juvenile reaches the age of 18.
most appropriate limit of liability will be to some extent,
influenced by both location and occupancy of the property concerned.
Waivers Recover Loss Against a Third Party
Waivers:When an insurer has agreed to indemnify a company for a loss,
it retains the right to recover its loss against a third party if
they caused the loss. If the insured party has contractually waived
the insurer’s right of recovery against another party, the
insurance policy can become null and void. The insured party should
ensure that he
neither accepted nor waived liability.
present there are many contracts that are regularly utilised in the
commercial environment that contain ‘hold harmless’,‘waiver of
subrogation’ or warranty clauses. These can be found predominantly
in maintenance agreements and some lease agreements.
to signing or recommending any of these agreements, always refer to
either the insurance broker or insurer who will either negotiate a
wording which is acceptable to all parties or, if this is not
possible, will endorse the contract on either the property or
All Exposures Are Insurable
all exposures are insurable events, eg. wear and tear, damage by
is surprising the number of persons who do not read their insurance
contract and/or obtain either legal advice or advice from a
professional insurance adviser as this is perhaps the only contract
that will ensure the ongoing viability of the business if a major
an insurance policy can be complex to read, it is important to
understand, at the very minimum, the policy exclusions and
conditions. If any part of the insurance contract causes concerns to
the purchaser, they may be able to negotiate changes to policy
However, this can only be accomplished where the insurance purchaser
understands the contract.
very large insurance programs, it may be advisable to recommend that
the insurance adviser/broker to meet with the owner, the owner’s
solicitor and the insurer to design (draft) policy wordings and
conditions. It is also reasonably common for a nominated loss
to both the owner and insurer to be agreed, as this can facilitate
claims settlement when losses occur.
Products and Changes to Taxation Provisions
Members should be aware that as with all market sectors, the
insurance industry is subject to continual review and there is the
potential for significant change in the future. New insurance
products regularly become available, and changes to taxation
provisions or other
regulation can effect the utilisation of insurance.
Insurance Covers are Specifically Tailored
indicated, this Guidance Note addresses broad issues, relating to the
property insurance environment and risk management. However, just as
the property market is not homogeneous and each property has
different characteristics, so it is with the insurance market and
policies of insurance. Thus the professional adviser needs to ensure
that the insurance covers are specifically tailored to individual
properties and their risk profile.