How Skipping Insurance Valuations Leads to Averaging Disasters

How Skipping Insurance Valuations Leads to Averaging Disasters

Elected trustees of bodies corporate carry a fiduciary duty to ensure adequate insurance cover for their schemes. This obligation is underscored by the Sectional Titles Schemes Management Act No. 8 of 2011, Prescribed Management Rule 23, which clearly states: "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."

While the rule seems straightforward, the question remains: who enforces this requirement and ensures the body corporate maintains sufficient cover? The answer often emerges only when disaster strikes and members discover the painful consequences of inadequate insurance.

Understanding Averaging in Insurance Claims

Insurance claims become subject to averaging when insurers discover underinsurance. Averaging allows the insurer to reduce claim payouts proportionally to the rate of underinsurance. This principle, while seemingly harsh, maintains fairness in the insurance system by ensuring policyholders pay premiums appropriate to their actual risk exposure.

A Real-World Example of Averaging

Consider a practical example that illustrates how averaging affects claim outcomes. A kitchen fire causes substantial damage to a unit, and the owner lodges a claim for R400,000. Given that the body corporate holds R15 million in insurance cover, settling this relatively minor claim should proceed quickly and smoothly, or so it seems.

The insurer begins by assessing the claim's merit, appointing a loss adjuster to evaluate the damage and verify adequate cover. After inspecting the fire damage, the loss adjuster confirms the claim's validity but delivers unexpected news: the insurer will pay only R300,000, not the full R400,000 claimed.

The Underinsurance Discovery

Why this reduction? The loss adjuster's investigation reveals that the true replacement cost for all units and common property totals R20 million when properly calculated. This figure includes essential components often overlooked: demolition costs, rubble removal, professional fees for architects and engineers, and VAT on all construction work.

However, the body corporate maintains cover for only R15 million, creating a 25 per cent underinsurance situation. Applying the averaging principle, the insurer reduces the claim payout by the same 25 per cent, leaving the owner with a R100,000 shortfall to manage from personal funds.

Where Trustee Liability Emerges

In this scenario, trustees failed to fulfil their fiduciary duty, creating grounds for personal liability for the insurance shortfall suffered by the damaged unit's owner. How did this happen? The trustees, attempting to save the body corporate approximately R2,800 in valuation fees, simply escalated the previous year's sum insured by 10 per cent rather than obtaining the legally required replacement cost valuation.

This decision, while appearing fiscally responsible on the surface, represents negligent behaviour that inadvertently voids trustee indemnity protection. By choosing to forgo professional valuation, trustees acted outside the legal framework designed to protect both the scheme and themselves.

The Alternative Scenario

Consider how differently this situation would unfold if trustees had obtained a professional valuation supporting the R15 million sum insured. In this case, when the claim shortfall emerged, the body corporate could legitimately challenge the valuation provider about the inadequate assessment. The liability would rest with the professional who provided the flawed valuation, not with the trustees who fulfilled their duty by obtaining proper professional advice.

This distinction is crucial: trustees who follow legal requirements and obtain professional valuations protect themselves from personal liability even when valuations prove inadequate. The responsibility then falls to the valuer and their professional indemnity insurance.

The False Economy of Skipping Valuations

Many trustees view the R2,500 to R3,000 cost of professional valuations as unnecessary expenditure, particularly when budgets are tight and members resist levy increases. However, this perspective ignores the actual risk-reward calculation.

A R2,800 valuation fee represents a tiny fraction of most schemes' total insurance premiums and an even smaller percentage of the property values being protected. When weighed against potential claim shortfalls running into hundreds of thousands of rand, and the personal liability exposure facing trustees, the valuation cost appears remarkably modest.

Furthermore, regular professional valuations often reveal that schemes are actually overinsured, potentially reducing premium costs and offsetting valuation fees. Even when valuations indicate increased cover requirements, the resulting premium adjustments reflect actual risk more accurately, benefiting the long-term financial health of the scheme.

Best Practices for Trustees

Prudent trustees approach insurance valuations as essential risk management tools rather than optional expenses. They schedule valuations well before the three-year requirement, particularly for larger schemes where accuracy is paramount. They select qualified valuers based on credentials and experience rather than the lowest cost alone.

Importantly, effective trustees educate themselves about replacement cost components, understanding that true replacement value extends beyond basic construction costs to include demolition, removal, professional fees, and VAT. This knowledge enables informed discussions with valuers and helps identify potentially inadequate assessments.

Protecting Your Scheme and Yourself

The legal requirement for three-yearly valuations exists for sound reasons: construction costs fluctuate, building standards evolve, and replacement costs generally trend upward over time. Trustees who view this requirement as a bureaucratic inconvenience rather than an essential protection misunderstand their role and expose themselves to significant personal risk.

Remember: the modest cost of professional valuations provides protection far exceeding the expense involved. Whether you're managing a complex in Sandton, Umhlanga, or Stellenbosch, ensure your scheme maintains current, professional valuations. Your members and your personal financial security depend on it.