Understanding cash settlements
Australian Financial Complaints Authority
By Emma Curtis
[Author note] Emma Curtis is the Lead Ombudsman for Insurance with the Australian Financial Complaints Authority, which is the financial sector ombudsman service.
When finalising an insurance claim, there may be the option to take a cash settlement. But it’s important consumers understand how a cash settlement works, and the pros and cons, before deciding whether to go down this path.
A cash settlement involves the insurance company paying a lump sum instead of arranging the repairs or replacements itself. While cash settlements offer flexibility – including the ability to choose your own tradespeople – they also come with risks, such as the payment amount falling short of the eventual cost of the work.
With the recent floods in Queensland and NSW, consumers will be having discussions with their insurer and should ensure that they are informed and understand the options available to them.
How cash settlements work
Once a claim has been lodged and approved, the question of a cash settlement can arise. The insurer will have assessed the claim and determined the cost of repair or replacement. Then, based on this assessment, they may offer a cash settlement.
If the insurer offers the policyholder a cash settlement, it must be fair in the circumstances. This means the insurer must exercise its discretion to cash settle in a fair and reasonable way, and the settlement amount must be sufficient for the policyholder to arrange repairs.
Before accepting a cash settlement, it’s crucial to understand the implications. Once you accept the offer, the insurer’s obligations usually end. You’ll be responsible for arranging repairs or replacement, and you could be left meeting some of the bill yourself if the cost ends up exceeding the settlement amount.
The benefits of cash settlements
On the plus side, a cash settlement can provide flexibility as you can choose how to use the funds, and it allows you to prioritise urgent fixes. It also eliminates the need to follow the insurer’s repair timelines and processes, which can sometimes be slow or restrictive.
Cash settlements provide freedom to choose how and when to repair or replace the damaged property. You won’t be restricted to the insurer’s preferred repairers or suppliers. You can shop around for quotes or opt for alternative solutions, such as upgrading to a better item.
For minor claims, a cash payout may be quicker and more straightforward than coordinating repairs through the insurer.
Understanding the risk
However, cash settlements also come with risks. The settlement amount may not always cover the full cost of repairs or replacement, particularly if market prices increase or the initial assessment was too low.
One key risk is the scope of works. Quotes, particularly for home repairs, are based on a scope of works. The scope of works set out all the required repairs to be completed. This can be included in the quote or in a separate document. The scope of works is important because if it is inadequate (e.g. does not include a room, wall or other works), then this will likely reduce the quoted cost. Therefore, people should be satisfied the scope of works is fair.
Another key risk is under-compensation. Insurers typically negotiate repair costs with their preferred service providers, often securing lower rates than the average consumer could negotiate, due to bulk agreements. If you opt for a cash settlement and decide to arrange repairs independently, you may find the insurer’s payout is insufficient to cover the actual repair costs through your chosen repairer. Additionally, some settlements may exclude costs such as delivery or installation, leaving you to cover these expenses.
Claims in home insurance, for example, can be complex. Repairs often involve engagement of multiple contractors, scopes of works and quotes. There may also be various policy benefits that are triggered which you may not have considered, such as temporary accommodation, removal of debris or removal and storage of contents.
Another risk is the potential for disputes. You might disagree with the insurer’s assessment of the damage or the value of the settlement. This can result in delays or the need for independent assessments, adding time and stress to what may already be a challenging situation.
It’s important to note that accepting a cash settlement can end the insurer’s obligations in relation to that claim. This means that if repair costs exceed the settlement amount or additional damage is discovered later, you may have to meet the difference yourself.
Making an informed decision
Cash settlements can be a valid option for policyholders who value flexibility and control. However, they require careful consideration and planning to avoid financial shortfalls.
You should carefully review your insurance policy terms, obtain multiple repair quotes, and seek clarification from your insurer about what the settlement includes. Advice from a legal or insurance expert may be needed to help ensure the settlement is fair and adequate, particularly when large sums are involved.
Consumers who rely on an insurance claims representative for cash settlements should also be aware of the potential financial risks. These representatives often charge a fee or take a percentage of the settlement amount, which reduces the total funds available for actual repairs. Policyholders may find themselves with insufficient funds to cover necessary fixes, leading to out-of-pocket expenses or lower-quality repairs.
Being informed about the potential risks and taking steps to address them can help you make a decision that meets your needs
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