Underinsurance is one of the biggest threats to the resilience and sustainability of UK businesses, with 83% of UK properties underinsured . Underinsurance occurs when a business buys insurance cover, but the cover bought is not enough to meet its requirements in the event of a loss. This can leave businesses with large, unexpected bills, impacting their ability to recover from a loss.
There are many reasons that you might not have enough insurance to cover a loss, including miscalculating cover, out-of-date valuations, knowingly underinsuring, seasonal increases, inflation, supply chain issues, and changes to the cost of materials. All of which we will cover in this article.
Underinsurance is not a new concept, and insurance brokers have worked tirelessly to explain the risks to clients, helping them to avoid underinsurance, however, the recent economic downturn and increased levels of inflation are impacting underinsurance in new ways which may mean those previously adequately insured need to review their insurance cover in more detail than before and with the expert help of an insurance broker.
What is underinsurance?
Underinsurance is when the insurance you buy is not enough to cover the losses when a claim is made. It could mean that the amount paid out for an insurance claim is lower than the amount you are expecting or that the insurer refuses to pay any money at all. In the event of a loss, your insurer may use the average clause to calculate the amount of any claims settlement.
Being underinsured can be a serious problem for individuals and businesses because it can leave them financially exposed in the event of an unexpected loss or damage. It is important to ensure that you have adequate insurance coverage that reflects the full value of your property or assets.
What is the definition of “average” in insurance policies and how can it affect a claim?
In insurance, a policy may include an “average” clause that limits the payout in case of underinsurance. If a property is insured for less than its actual cost to rebuild, the payout for a total loss will be reduced proportionally. For instance, if the reinstatement cost of a property is £1,000,000 and only insured for £500,000, when a total loss occurs; then the insurer will pay only £250,000, leaving the policyholder to cover the remaining cost. Similarly, any partial loss will be reduced in the same proportion, considering any excess that applies.
Although some policies may not include the condition of average, failure to insure adequately can still lead to financial losses. Under the Insurance Act 2015, policyholders are obligated to disclose any material information about the risk they are insuring, and insurers may void a policy if they believe the policyholder was reckless or deliberate in underinsuring the property. This means that the policy would be cancelled, and no payout would be made, leaving the policyholder uninsured for the full amount of the loss.
Why are businesses underinsured?
There are several reasons why businesses can become underinsured, whether intentionally or unintentionally.
Miscalculating the cover needed can happen if the market value of the property is used as the basis of insurance rather than the rebuild value as we explore in the next section.
It is also worth noting that the definition of profit used for business interruption insurance differs from the definition of profit for accounting purposes. In the case of business insurance, gross profit is defined as turnover minus the cost of raw materials and other expenses that are directly linked to turnover.
Out-of-date valuations can result in underinsurance, even if your insurer has been applying the index linking figure to the policy, if it was based on an out-of-date number the adjustment won’t bridge the gap and you could still be underinsured. It is worth having your properties valued every three years by an RICS (Royal Institution of Chartered Surveyors) approved surveyor.
Knowingly underinsuring your business assets could be tempting in the current economic environment when there is a keen focus on costs and lowering sums insured or removing coverage elements can reduce premiums. However, doing so is risky, as it may result in the items assumed to be covered being either underinsured or not insured at all.
Seasonal increases affect retail businesses that may need to increase their stock levels significantly to ensure they can meet customer demand. Most package shop insurance policies will have a seasonal stock increase clause, which specifies a percentage increase in the stock sum insured during busy periods. This ensures that the policy will cover any additional stock during those periods, giving business owners peace of mind. It’s important to note that this additional coverage is only applicable during the specified period Business owners should ensure that the sums insured are correct to avoid being left out of pocket in the event of a claim.
Why is property insurance an underinsurance problem?
One of the most prevalent examples is when a business provides its insurance broker with the market value of their property rather than the cost of rebuilding it, an Allianz survey showed that 29% of those who own a business property used the market value to calculate the cost of rebuilding. 
The rebuild cost of your property should include paths, driveways, walls, fences, garages, and outbuildings as well as costs including materials, labour, architects fees, surveyors and other legal fees, the cost of demolition and debris removal, VAT (as necessary), any public authority or planning costs and inflation or other increasing costs that happen during the policy period as well as any rebuilding period. There could be additional costs if the property is listed or has any special features.
If the building is then destroyed in a catastrophic event such as a fire, the cost of rebuilding the property could surpass its market value, leaving the property owner to cover the shortfall between the market value and the rebuilding costs.
Which policies are commonly underinsured by businesses?
While any commercial insurance policy can be underinsured, insurance companies report that the following policies are frequently underinsured:
Commercial Properties – Business owners often fail to consider the actual cost of rebuilding a building and only focus on its market value. Neglecting to periodically reassess the value of your property and adjust your policy accordingly could result in underinsurance and leave your business vulnerable to losses. High levels of inflation and the increased cost of building materials are leading to double-digit index linking, index linking is a calculation to automatically increase your sums insured in line with inflation and other factors that affect prices. If the sum insured is set correctly then index linking should mean that the sum insured remains adequate.
Machinery and Plant – Maintaining an updated list of all machinery and plant together with their replacement values is critical to ensure adequate coverage when making a claim. Make sure to reflect any changes in your machinery and plant by adjusting your sum insured.
Business Interruption – The inability to continue business operations after a crisis can be catastrophic. Having a current continuity plan and insurance cover is essential. The risk is not just the sum insured being adequate but also having an indemnity period that allows time to recover from a loss. It is difficult to predict how long this can take, generally it is likely to take at least 12 months to get debris removed, local authority agreement to the rebuild plans and for work to start, when you then consider that your business will need to recover lost clients and build back revenue, we normally recommend an indemnity period of at least 24 months as a starting point.
Cyber Insurance – Data breaches pose an increasing threat to businesses of any size. Improving your cybersecurity and developing an action plan are now necessary business practices to offset the potentially significant losses of a data breach.
By regularly reviewing your policies and working with a reputable insurance provider, you can avoid underinsurance and protect your business from unforeseen losses.
How can I avoid underinsurance?
The best thing to do is to talk to your insurance broker if you think you could be underinsured. Your insurance program should integrate with your business continuity and business resilience planning, so talking to your broker will enable you to assess where you are, fix the problem, and be prepared if a claim occurs.
Here are three tips to avoid underinsurance;
- Valuations – having your building valued by an RICS (Royal Institution of Chartered Surveyors) approved surveyor every three years can avoid the pitfalls of underinsurance. We recommend using Rebuild Cost Assessment which, in most cases, can provide a desk-top valuation using a combination of clever information technology and in-house expertise. This information can then be shared with your insurance broker to check your insurance sums insured are correct and if not, take action to amend them.
- Review – find out about all the insurance covers available even if you don’t think you need them. This could include cyber insurance or directors & officers; we are happy to explain the various types of insurance available based on your business activities.
- Update – you don’t have to wait until renewal to change your insurance. If you think you are underinsured or you have changed what you do, added a new service, or are delivering your product or services to clients differently, or a property you manage has changed use then you will need to update your insurer. Make sure that the information and sums insured you provide are as accurate as possible.
What to do next
If you think you are underinsured or there are insurance covers you would like to add to your program please get in touch with the team on (insert number), we are happy to talk through your insurance program with you.
[4} Rebuild cost assessment https://www.rebuildcostassessment.com