Too often investors do a quick once-over on the insurance front. But when it comes to commercial property that’s a mistake – instead it’s worth getting to grips with the fundamentals, writes Miriam Bell.
1 November 2018
It’s sad but true: It’s often a disaster – be it big or small – that forces people to realise just how critical it can be to have comprehensive insurance cover in place. New Zealanders often have a casual relationship to insurance, with vehicle insurance coming first in their affections.
Investors are probably more attuned to the importance of insurance for their properties than many. But commercial property insurance is a whole different ball game to residential. It is not a case of one size fits all or even one policy fits one property type. Rather it’s a complex, multi-faceted business. So here’s our guide to the fundamentals of insuring a commercial property.
Know Your Property
Before organising insurance for a commercial property, it is critical that the property owner knows and understands every aspect of their property and the potential risks surrounding it.
Insurance Council chief executive Tim Grafton says there is a standard list of factors that must be investigated. The more obvious of these include assessing whether the building is structurally sound and compliant with the Building Code; and finding out the NBS rating and establishing how earthquake vulnerable the property is.
But there are other, less well known elements to look into too. These include a building’s non-structural seismic restraints (which hold items like the air conditioning system, electrics, the sprinkler system in the ceiling), passive fire elements (like fire walls and dampers) and cladding.
People have become more aware of potential cladding issues in the wake of the Grenfell Tower disaster. But there is often a lack of knowledge, and compliance, around non-structural seismic restraints and passive fire elements, Grafton says.
“Yet, in terms of insurability, it’s important to know if these elements are compliant with the regulations. If a property owner doesn’t have all these aspects of a property fully checked out, they could be at risk of a good deal of loss.”
‘It is critical to get the three-pronged insurance mix, which covers the building itself, the rental income, and the liability risks, right’ RENE SWINDLEY
For veteran commercial investor Jeff Brill, insurance considerations must be part of the comprehensive due diligence that should be conducted on a property before buying it. Information gained from the initial evaluation process, engineering evaluations and the NBS rating, as well as the lease agreement, will all help to inform insurance decisions, he says.
“It’s also worth talking to the vendor and the agent about what type of insurance they have on the property. As long as you are not planning to change the lease arrangement or the building use, that can be a helpful guide.”
Commercial property insurance structures are often complicated as they involve a range of different must-have policies. Stripped back to the essentials these policies should provide cover for the building for replacement value, business interruption (loss of rental income due to building damage), public liability insurance and statutory liability insurance.
Crombie Lockwood learning and development specialist Alan Race says the policy definition should include structures of every description. This includes landlords’ fixtures, fittings, walls, paths, fences, roads, gates, signs, under and above ground storage and all drainage and electrical connections on the premises.
“It is important that if replacement cover is being arranged that the valuer takes all of these items into account when calculating their valuation. The building and loss of rents policies should also include loss by natural disaster.”
Frank Risk Management director Rene Swindley says it is critical to determine correctly the three-pronged insurance mix - which covers the building itself, the rental income, and the liability risks.
The building should always be insured on the basis of a replacement valuation (from a registered valuer or quantity surveyor), he says. Further, the rental income insured value needs to include the rental income itself and outgoings such as rates and insurance (that if the building was not tenanted the property owner would have to fund).
“A lot of commercial property owners select an insured figure that they believe will ‘do the trick’ should the building be a total loss. However, this approach is not wise and it is important that the replacement value has a formal basis of calculation, not to mention that the lease agreement has a requirement for replacement value.”
Meanwhile, the public liability and statutory liability insurance provide coverage beyond the actual property. Public liability protects the property owner for any damage caused to tenant contents, while statutory liability protects the property owner if there is an injury sustained at the property.
Race says these policies are crucial because a property owner can be held liable for damage to a third party’s property or person if it is caused by their building.
“But the law in respect of liability is complex and all the aspects of a case would need to be determined before a policy would trigger a claim. Just because damage occurs, the reasons why need to be understood to clarify who was at fault and responsible to make good the loss or damage.”
In his view, policy limits of liability need to be at least $5,000,000 and upwards of $10,000,000 if the site to be insured is part of a mall or larger body corporate.
Grafton adds that if the property owner is set up as a company they should also get directors’ and officers’ liability insurance. This provides protection for directors and officers for wrongful acts committed within their capacity as a director or an officer. It includes defence costs and is triggered when a claim is made.
Who Covers What
One major difference with commercial property landlording is that in most cases the tenant is responsible for the payment of the building insurance premium.
‘These liability policies are crucial because a property owner can be held liable for damage to a third party’s property or person if it is caused by their building’ ALAN RACE
Swindley says the commonly used ADLS lease agreement specifies the high level structure of the insurance to be put in place for the commercial building. It includes the insurance premium as an outgoing that is the tenants’ responsibility.
“If the landlord arranges more cover than is specified in the lease (for example, 24 months’ rent) then technically the tenant is not responsible for the cost of this additional cover. But, post major earthquake events in Wellington and Christchurch, we consider 12 months of rents cover to be far too little and recommend a minimum 24 months.”
Usually the property owner will arrange the insurance and then invoice the cost to the tenant. It is not a good idea to let the tenant arrange the insurance, he says. “If arranged by the tenant, the tenant could invalidate the cover if they don’t pay the premium or fail to disclose a material fact.”
When it comes to tenants, the experts agree that it’s up to the tenant if they insure themselves and their property. While most will have third party cover, a landlord can mandate that they get insurance. If they don’t have insurance they would have to pay for damage to the property themselves.
However, it’s worth noting that The Property Law Act 2007 means a landlord cannot recover from their tenant for unintentional damage to the property, Race points out. “The intent being that the party paying for the insurance of the premises should also be entitled to the benefit of that insurance except in particular circumstances.”
He says that where a landlord is required to maintain building insurance and the tenant negligently causes damage to the premises, the landlord is now unable to recover the cost of the repairs from the tenant. The exceptions to this are if the tenant intentionally damages the premises, or commits an act which makes any insurance indemnity irrecoverable.
Commercial insurance can be a difficult area: no property is the same while all policies differ in the fine print with different exclusions and conditions. This means one size does not fit all.
For this reason, all our experts proffer the same, final piece of advice: It pays for investors to go through an insurance adviser.
But Brill says it is important to go to an adviser who specialises in commercial property. “Don’t just go with the insurer you use for your house. You need someone who knows what they are doing. They will evaluate your risks and requirements properly and they may well get you lower premiums.”