Should the Client Include GST in Their Sum Insured on Business Insurance?

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Like with so many other questions in insurance, it depends on the policy. To my mind as an insurer never has to meet the cost of the Goods and Services Tax (“GST”) where the business owner is registered for GST and has a 100% Input Tax Credit (“ITC”) when it comes to a claim, then GST should, as a matter of course, not be included in the Sum Insured.
However, like power point sockets around the world and railway gauges around Australia, there is no standardisation and people get caught out every day.
Before elaborating on my view of what should be standard, let us look at what really happens when it comes to a claim.  Let us assume the Insured owns a building worth $1,000, 000 plus GST of $100,000 a total value of $1,100,000.
Assuming the building is totally destroyed in the fire, liability has been accepted, and the building is insured for the full amount of the rebuilding including architects and engineer’s fees, then the insurer will take one of two courses of action.
The first is they will authorise reinstatement of the building and as the Tax Invoice is made out to the Insurer, they will pay $1,100,000 to the builder, then claim back the $100,000 GST proportion as a Input Tax Credit on their next Business Activity Statement (“BAS”).  The net cost to the insurer is therefore $1,000,000.

The more likely option is they will advise the Insured that they have no objection to the Insured authorising repairs to a particular builder. The Insured authorises the repairs and the Tax Invoice is made out to the Insured. He, in turn, lodges the invoice to their insurer and the insurer issues a cheque for $1,000,000 (the net of GST amount) and forwards it to the Insured. The Insured then claims the $100,000 GST in their BAS as an Input Tax Credit and with this amount, they are fully indemnified.

Turning to the policy wordings, most policies on the Australian market do not require the Insured to include GST as part of the property or business interruption insurance sums insured/declared values. This is certainly the case with the vast majority of cluster group and international broker policies negotiated with their various partner insurers.

However, some policies, particularly those issued by some direct insurers (those that do not distrubute through an insurance broker) require the Insured to insure inclusive of GST. These Insurers will never pay out the Sum Insured but rather will deduct 1/11 from the sum insured to take into account the GST. Worse still, they will carry out the test for average on the GST inclusive amount. Worse again, some of these policies deduct the GST from a Policy Sub-Limit.

As the Insurer will never met the GST amount, my position is that this is unfair. I appreciate that the underwriter will argue that they apply a cheaper rate to compensate for the 1/11 never paid, but I think the issue is much more than price.

The concern I have is that so many clients ‘copy quote’. This is a term I use when a client takes their existing insurance coverage and has it quoted by another insurer or broker. So let us take the client that had the $1,100,000 building mentioned at the start of this blog entry. They have had their building rebuilt but fear that as they have had a claim they may be slugged with a higher premium, so they obtain quotes. Their old policy had a sum insured of $1,000,000 and, finding they were fully insured, simply have all insurers quote on this sum insured.

The insurer(s) that require their clients to include GST a quote on the $1,000,000 sum insured and are, of course by their own admission, cheaper. They win the business and in the cases I have seen, because they do not bring the need to insure the property inclusive to GST, the sum insured remains at $1,000,000. Should the same building be destroyed a second time, the new insurer will only pay $909,090.90. The client naturally feels aggrieved and cheated.

Even with a few small claims of which I have been asked to provide an opinion, I see this sort of thing go on. Say an Insured loses say $5,500 worth of goods due to theft where their policy has a $5,000 theft Sub-Limit. In this case, under the GST inclusive style policies, the client feels cheated when even after the Insured has deducted the GST component from their loss and claim, only $5,000, the Policy Sub-Limit, they find that insurer deducts the GST from the Sub-Limit and only pays the client $4,545,46.

I appreciate that competition in any industry is good, but I do object to Insureds going away from a claim feeling hoodwinked. This, of course, goes against the very first principle of general insurance ‘utmost good faith’. In arguably the earliest reported case on this principle as it applies to insurance, Lord Mansfield said in Carter v Boehm (1766) 3 Burr 1905:
“Good faith forbids either party, by concealing what he privately knows, to draw the other into a bargain from his ignorance of that fact, and his believing the contrary.”
To my mind, based on this judgment, which was proclaimed 4 years before Captain Cook sighted Australia, any insurer that requires an insured to insure for anything such as GST (which the insurer knows that they never have to pay) is indeed drawing the Insured into what they believe to be a bargain (cheaper insurance/a cheaper insurance rate) by the Insured’s igorance of the fact that he/she needs to increase his sum insured/declared value by 1/11 to compare apples with apples, and more importantly, be fully insured.

I am sure that some underwriters will not agree with me. The question then falls on to the level of warning the Insured is provided. I believe a court should impose Lord Denning’s famous red hand test to the requirement for an Insured to be required to include the GST when it is never going to be paid.  For those not familiar with the rule, Lord Denning in the case of  J Spurling Ltd v Bradshaw [1956] EWCA Civ 3 said:

“I quite agree that the more unreasonable a clause is, the greater the notice which must be given to it. Some clauses which I have seen would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient. “
The wordings I have seen that require GST to be included in the Sum Insured where the client is entitled to claim a 100% ITC come nowhere near to meeting this test.

For the brokers reading this entry, if you lose a client to a direct insurer on the basis of a cheaper price, it may not be cheaper at all and you may wish to offer the appropriate advice to your client.

Anyone with access to LMI PolicyComparison is encouraged to ensure that the policy they are using, are quoting against or being quoted against, is on a GST inclusive or exclusive basis.

If anyone has a different view to me on this, I would be happy to discuss the subject further.

3 responses to “Should the Client Include GST in Their Sum Insured on Business Insurance?”

  1. […] Insured to include the GST in the sum insured. Further, that sub-limits also include the GST. See Should the client include GST in their sum insured on Business Insurance? A couple of weeks before that I asked where had the insurance industries social conscience […]

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