Condo premiums continue to increase at unprecedented levels – this article explains why you need to pay attention. Premiums are comprised of two major parts:
1 – The rate that the insurance company applies per $100 of coverage based on an estimate 2 – The cost estimate
The first is controlled by the insurance market. The second is the result of whether the costing performed was accurate. Together, these factors determine how high (or low) your premiums will be.
This is the part that must catch your attention – the cost estimate. You may think that all estimates are created equal and therefore should be quite similar, but how well do you understand the underlying process to get to said estimate?
To arrive at a sound and accurate estimate that you trust, you first need to understand the process that derived the data.
THERE ARE DIFFERENT TYPES OF COSTING:
It is important to determine whether
the costing method being applied will provide the best results for you.
Reproduction cost estimates the cost based on an exact duplicate or replica of the building being appraised, using the same materials, construction standards, design, layout, and quality of workmanship and embodying all the deficiencies, super-adequacies, and obsolescence of the subject building.
Replacement cost is based on the estimate to construct, at current prices as of a specific date, a substitute for a building or other improvement, using modern materials and current standards, design, and layout.
Reconstruction cost is based on costing to rebuild a structure and based on experience and factors related to actual losses such as economies of scale, unexpected cost differences such as accessing a job site in a built-out neighborhood or having to frequently work between and among existing buildings while being respectful of neighboring property and noise levels.
NOTE: Reconstruction is the correct approach for completing insurance appraisals. The above definitions should be accompanied by a credible source of the definition, otherwise, it is concocted and leads to a false understanding of the proper method.
ABOVE METHODS CAN BE APPLIED BY UTILIZING ONE OF THE FOLLOWING COSTING
Quantity Surveyor Detailed Estimate – this is a detailed based estimate that typically identifies and breaks down materials and labour into individual components but if typically applied can be costly and time-consuming. It is important that proper overhead and profit factors are included. This approach applies to Reproduction Cost or Replacement Cost if a newer building with no super or sub adequacies.
National Costing Databases – this is a form of an estimated cost developed by utilizing comprehensive databases derived over an extended period in the marketplace and then applied utilizing square foot, unit in place or model-based costing. Where buildings are newer the results will be a Replacement Cost and Reconstruction Cost. The costing analysis can apply algorithms to develop and compile an estimate.
Proprietary Costing Databases – typically created by a company similar to national costing databases but generally less sophisticated and susceptible to failure or shortcomings if not rigorously updated with an extensive amount of time required, particularly when covering a significant number of locations where it is applied. These databases typically generate a Replacement Cost estimate.
Project Comparison or Market Estimate – this is a comparison based on projects which must be similar and current in nature otherwise becomes outdated or skewed if any significant changes occur in the marketplace related to costing. These typically generate Reproduction or Replacement Cost estimate.
For insurance appraisals the Reconstruction Cost is specifically tailored to insurance appraisals and encompasses all the aspects of what can be expected should a total loss occur.
ADDITIONAL FACTORS THAT IMPACT THE ACCURACY OF THE ESTIMATE:
Quantity Takeoffs – garbage in equals garbage out therefore the application and support of proper AutoCAD systems are critical to ensuring accurate results.
Exclusions & Inclusions for Condominiums/Strata’s – The impact on the cost estimate can vary depending on who is responsible for items based on bylaws and agreements. An example is exclusive areas (usually common but which are utilized by an owner such as a rear yard deck, an apartment sunroom, or appliances) which may or may not be included in the insurance policy. Another example encountered on a regular basis is who is responsible for ownership of the perimeter fences. A simple question but probably one of the most difficult to answer without proper investigation.
Applying Multiple Costing Sources for Veracity – each of the four methods previously discussed have their strengths and weaknesses. It is incumbent on insurance appraisal providers to utilize more than one costing estimate source or method and use their knowledge to understand – and explain – where the best applies. One source may be ideal for site improvement costs whereas another source will be superior for building improvements.
CurrentBuilding Codes – an example would be if a building has a partial or no sprinkler system and current building code requires a full system, the appraisal must account for this requirement.
Site Improvement Considerations – aside from the building, the site improvements must be considered. This was abundantly clear in the Fort McMurray fires when the site improvements were eliminated. Some insurers require underground services to be covered, which can be a very significant cost, especially in high-risk seismic zones. These must be clearly defined as being included or excluded.
DemolitionEstimates – if separate demolition costs are not provided, then the insurer will draw funds away from the building estimate. It is important that proper analysis is completed.
ADDITIONAL PROTECTION AN APPRAISER CAN PROVIDE:
Errors & omission insurance of at least
$5,000,000 or more
Workers’ Compensation Board in Alberta
and WorkSafe in BC – protects clients against any onsite occurrences of appraisers
HOW TO KNOW IF A COST ESTIMATE IS ACCURATE? STANDARDS.
Users of appraisal reports sometimes question the conclusions reached, believing the value estimate to be too high or low. For the reader to understand whether the report conclusions are credible, there must be a basis for measuring the veracity of the numbers. It is therefore incumbent on the reader to understand the basis of development, methodologies utilized, and the reporting process. It is also incumbent for the insurance appraiser to explain their processes and the standard they are applying.
Within the sphere of our appraisal expertise, we are often engaged to review other appraiser’s work product for purposes of litigation. An appraisal review requires substantial expertise in the subject matter of the report and a thorough understanding of applicable ethical and professional standards.
The appraisal review process can identify flaws in both the methodologies utilized and in the compliance with applicable standards. Failures identified in either case lead to review conclusions that the report under review is not credible, and by extension, that the value conclusion cannot be relied upon. Especially in insurance appraisals, our experience is that most reports fail the review process and the conclusions reached are simply not credible.
MOST IMPORTANT THINGS TO CONSIDER BEFORE ENGAGING AN APPRAISER (to complete an insurance appraisal):
Is the appraiser a member of a nationally recognised appraisal association such as the Canadian National Association of Real Estate Appraisers (CNAREA) or the Appraisal Institute of Canada (AIC)?
Does the appraiser hold the correct designations to complete the work (DAC or AACI)? Both organisations have professional standards for the development and reporting of appraisal results. The completion of the report requires that the appraiser certifies and signs the report indicating compliance with the standards. This compliance protects the client ensuring that a professional product is received, and the results can be relied upon.
Is the appraiser experienced in similar assignments and knowledgeable of your geographical area? How might you find out?
Ask to see their previous sample reporting – are they relevant?
Ask for a list of their clientele – is it widespread? Will they provide references?
Insurance appraisals are a specialty. All designated appraisers are not necessarily experienced nor competent in this field. Their inadequacies may cost you heavily in inflated premiums; therefore, it is vital to seek the experts.
Our experience and proven expertise in this field are respected by the courts, insurance companies, and by our many valued clients. We trust the information above will help to determine whether the insurance appraiser you seek is adequate for your assignment.
COMING SOON: In my next article, I discuss the Alberta Condominium Regulations regarding the requirements for the Standard Insurable Unit Description (SIUD) – its impact on appraisal estimates, misconceptions, and factors you may consider when creating the document.