The Escalator Clause in Short Term Insurance

As a consumer you probably feel that there are far too many clauses applicable where short-term insurance is concerned. Another one you need to take notice of if you have any short-term insurance policies is called the escalator clause.

What is the meaning of the Escalator Clause?

Let us look at a number of definitions found on the Internet:

1. An escalator clause is a clause in a lease or contract that guarantees a change in the agreement price once a particular factor beyond control of either party affecting the value has been determined.

2. A provision of an agreement that provides for automatic adjustments in payments based on an economic index that neither party to the agreement controls.

3. A clause in a contract, lease or mortgage providing for increases in wages, rent or interest, based on fluctuations in certain economic indexes, costs or taxes.

So, the escalator clause will allow the insurance company to automatically increase insurance premiums, usually on the renewal date of an insurance policy. The increase will be in line with the current inflation rate or the consumer price index.

Where is the escalator clause applied?

The escalator clause is not only applicable to insurance but can be used in a number of contracts. In the building industry it becomes particularly important. A high-rise building may take years to complete. The escalator clause will allow the building contractor to increase the contract price should the inflation rate, or any other factor, push up the cost of building. The escalator clause is also used in most lease or rental agreements.

The inflation beast

Inflation is indeed the reason why you will find the escalator clause included in most insurance policies. In the insurance industry the escalator clause is referred to as an inflation-guard endorsement.

Home owners insurance

Many people query why their home owners insurance increases every year. The reason is to cover the increase in the replacement cost should your home be damaged. The escalator clause means that not only your insurance premium, but also the maximum amount you are insured for will be increased in line with the inflation rate. The insurance company, and the bank where you have your home loan, must make sure that you are adequately insured in case of total destruction.

To rebuild your home from the ground, should it burn down in a fire, will cost much more each year as building costs, in particular, have escalated. Local labour costs, the price and availability of materials as well as the style of the construction all play a role in the calculation of the escalation percentage each year.

But the value of property has decreased in the last year

One may be tempted to ask your insurance company to decrease your home owners insurance as your property is probably worth less after the slump in the property market. Here one needs to remember that this insurance is based on replacement value and not current market value.

Content Insurance and car insurance

The same rule applies to content insurance – your contents are insured at replacement value and therefore the escalator clause is also applicable in content or householder insurance. If you do not ensure that you are sufficiently covered the average clause will be applied should you have to claim from your insurance. This is not only applicable in the case of a total loss but even to the loss of just one item.

What happens to my car insurance?

Car insurance is the exception to the rule – your car is insured for market value and not replacement value. Your car insurance should therefore decrease each year as the value drops. In practice this is not always the case as insurance rates could have increased due to inflation and overall claims for the year. You should, however check with your insurance company on an annual basis. Being over-insured is, like under-insurance, of no benefit to you.

Can I ask for my insurance to be adjusted if I feel the escalation amount is too high?

You can indeed ask for your insurance cover to be reduced if you feel that the increase is exorbitant. If you have a home loan the bank will, however, insist that you remain sufficiently covered to protect its own interest.

Whether it is your home owners or content insurance, reducing your insurance could be a matter of penny wise and pound foolish. The short-term insurance ombudsman has recently again warned South Africans that it is their own responsibility to ensure they are sufficiently covered. The ombudsman will not be able to come to your rescue if you are underinsured.