You may have come across the term ‘index linked’ in relation to economics and finance but might be wondering, what does it have to do with letting a property?
And that’s a fair question – but it’s one all landlords need to know the answer to, so they can make sure their buildings insurance provides enough cover.
Quite simply, it’s a way of making sure that the value of a financial product is protected against rises in costs in the wider economy. A facility is put in place to track rises in costs – such as inflation and the cost of living – and then a similar percentage increase is applied to the value of the product.
Many common financial products, such as pensions, wages, insurance payouts and even train fares are index linked to inflation. In the case of buildings insurance, index linking typically relates to the specific rebuild costs of a property, including labour and professional services required.
It could even apply to rents, although index linking is generally only applied in the commercial and social sectors, where it’s typically stated in the contract that rents will rise in line with a recognised index, such as the Retail Price Index (RPI).
Probably the biggest area where this will affect you is your landlord insurance policy.
When you take out specialist landlord insurance, it will include cover for the cost of rebuilding the property – for example, if it were to burn down or be destroyed by a storm. To have the right level of cover, the insurer must be fully aware of the current rebuild cost.
And rises to rebuild and other costs can happen quickly. For example, although property prices have risen significantly for many during the pandemic, so have rebuild costs – to such an extent that in some cases property owners are finding it costs more to rebuild their property than it’s actually worth!
Calculating the rebuild value is the landlord’s responsibility, although you will typically get help and guidance if you have a mortgage valuation carried out or request one yourself from a RICS-qualified surveyor. As a guide, you can secure an initial estimate from BCIS via their free online calculator.
If you fail to keep your rebuild valuation up to date with your insurer, you may find that if the worst happens and your buy to let property is damaged beyond repair, any buildings insurance claim settlement may leave you out of pocket.
This is because you’ll be underinsured and the ‘average clause’ will be applied to any claim you make, resulting in a much lower payout. Insurers apply the ‘average clause’ to claims where they believe there’s inadequate cover in place, and will reduce the amount they pay out by the same proportion as the home is underinsured. For example, if you estimate the rebuild cost of your home is £500,000 but the actual rebuild cost is £1 million, then your insurer would only have to pay out a maximum of £500,000 – half the actual rebuild cost. Find out more in our article, How to avoid underinsurance: A landlord’s guide.
The benefit of having an index linked insurance policy is that if the cost of insured items (e.g. fencing, brickwork, roofing, internal fixtures and fittings) increases during the term of the policy, this rise is automatically covered by your insurance.
Index linking also means you don’t have to review the rebuild cost yourself every time you renew your policy, as it will be automatically adjusted. So, assuming the rebuild valuation you gave initially to your insurer was correct, then an index linked policy should continue to protect you should anything serious happen to your property.
“The average degree of underinsurance is 40 per cent. One of the reasons this can happen is due to a rise in the increase in costs of materials and labour which we have seen during the pandemic. Although you can get a valuation for re-build costs online, as both property prices and costs have gone up, it might be worth considering a professional valuation for yourself and one which can help reassure insurance companies that the correct cover is being paid for.”
– Steve Barnes, Associate Director at Hamilton Fraser Total Landlord Insurance
Most property insurance products are index linked, but not all, so it’s important to check whether your policy is. And when you next renew your landlord insurance, make sure that the rebuild cost for your property is accurate and you’re not under-insured. You can read more about the risks of being underinsured in our article, How to avoid underinsurance: A landlord’s guide.
To check your current property rebuild costs, visit the Building Cost Information Service (BCIS) website.
If you would like any further information on buildings insurance – or you’re interested in finding out more about our own Total Landlord Insurance Premier policy – just give the team a call on 0800 63 43 880.