Underinsurance: Are YOU sure you’re adequately insured?

Underinsurance continues to be a serious issue for any business or enterprise affected, as well as the insurers and insurance brokers that try to deal with the consequences. "Am I insured? And am I insured for enough?" are common questions when faced with loss or significant damage. The worst possible outcome is to be informed that you don’t have adequate cover for a full payout, or even a partial payout.

So, we’re kicking off with a reminder of what underinsurance is, how it happens, and the problems it causes, before focusing on the consequences, related costs, and examples that show the true impact.

The cost of underinsurance

Put simply, underinsurance is when a policy’s cover level equates to less than the correct total value that should be insured. For example, you own a business premises and it’s insured for £200,000 in total. A fire at the building not only destroys the building, but also any stock, machinery, IT equipment, and more miscellaneous items such as physical files, fittings, and so on. When the post-incident numbers are calculated, the true and complete value is closer to £400,000 – creating a marked difference of £200,000 or, to look at it another way, 50 per cent underinsurance. 

Even if you have an approved fire alarm and other methods designed to protect your business and satisfy your insurers, if the value submitted in the first place is under, then there could be trouble in store in terms of meeting your rebuild and recovery costs. 

In this example, the insurer would only be liable for 50 per cent of the actual claim and would only pay £100,000 to the insured. What you will notice here is that although the difference is 50 per cent, what is received by the insured is 25 per cent of the total loss – which can be a massive shock in financial terms.

Having got through the physical and emotional trauma of this happening to your business, being told by your insurer that they can justifiably not pay the full claim amount may feel like adding insult to injury. But the insurer is not doing this to be difficult or ruin your livelihood – it’s one of the fundamental principles of the insurance industry. 

The main issue with underinsurance? You may not even know that you have a problem until you need to make a claim.

Understanding the average rule

Before we move away from the technicalities, it’s important to reiterate the meaning of the ‘average rule’ or ‘average clause’ and its place in underinsurance, because insurers use this to calculate claims and decide what your payout will be if you’re underinsured.

When the amount you’re insured by is less than the actual value of the property, insurers may reduce the claim payout proportionally. For example, if a property is insured for 50 per cent of its actual value, the insurer may only cover and therefore pay up to 50 per cent of the claim in the event of a loss.

This principle encourages policyholders to adequately insure their property to avoid being penalised in case of a claim. 

In some instances, the insurer may be entitled to void the policy altogether if it materialises that the risk was unfairly presented. We’ve used the example of 50 per cent to keep the numbers straightforward, but at that level of underinsurance, the insurer could deem it reckless and possibly deliberate, which gives them the right to completely void the policy under the Insurance Act 2015.

Why underinsurance happens

One explanation for underinsurance occurring is that there was simply a failure or oversight in understanding what is required to be insured. There’s also that other common pitfall of people thinking, “It’ll never happen to me, so why waste money on something so unlikely?”. This is a weak defence should something then occur, and insurers will rightly say that this was a failure to accurately declare sums insured. 

Other typical reasons for underinsurance are that a valuation is out of date and therefore hasn’t accounted for inflation and other changes over time; incorrect calculations were made in the first place; circumstances have changed; and even the increasingly hard market that’s affected all aspects of the insurance sector. 

In addition, there might be insufficient limits within the policy, or perhaps advice has been sought from an unqualified person who fails to make an allowance for the items required to be included within a building's declared value. This subject is covered in more detail by our podcasts, which can be found here.

Different types of underinsurance

Underinsurance and the repercussions extend much further than the cases we’ve highlighted above. To add further context, some of the most common scenarios presented to insurers are as follows:

• Property: Failure to declare the correct sum insured when you set up the policy. Let’s say a hurricane took off the roof, upon which you had recently installed solar panels, yet you had chosen not to add the solar panels to your insurance policy. Suddenly there’s not just a hole where the roof used to be, but also in your business account as you’re underinsured.
• Business interruption: Those two words can invoke anxiety and nervousness in even the most fearless and flexible of people. And that’s unsurprising as this is an area where so many instances of underinsurance occur. When the wheels of industry grind to a halt or fall off, is there a back-up plan covered by your business-related insurance policy(ies)? Let’s return to that building where the roof has blown off. The business will need to temporarily relocate and rent, and bills will need to be paid on temporary premises, plus there will be delays in fulfilling orders or finishing jobs, which may incur penalties in unpaid invoices. A further problem is that cover may only protect your business for a limited amount of time when a business interruption event occurs, but the disruption may last much longer than imagined. It’s therefore important that you set the correct level of sum insured and indemnity period for this area of cover. If insuring on a Gross Revenue or Insurable Profit basis, then you’ll need to ensure it allows for growth throughout the policy and indemnity periods. This is just one example of what business interruption insurance cover is built for. But if you’ve underpaid on this, then you’re still underinsured.
• Cyber liability: While still a relative newcomer to the challenging world of underinsurance, inadequate cyber cover is a rapidly growing problem. From data breaches to phishing scams, from human error to major system infiltration, corporate cybercrime is a thriving industry. It’s not only essential that your business has a cyber insurance policy, but it should include business interruption cover which ideally should mirror the exposure that could be caused by the maximum level of interruption to your business.
• Portable equipment: While it’s important to consider the big things, don’t overlook other smaller more portable items such as laptops, speakers, and projectors. Let’s consider a new scenario, whereby two businesses are due to present at a conference, but both have several items lost in transit. Company A has insured various items randomly… a few laptops, and a couple of projectors. Company B followed the advice of their insurance broker to take out insurance based on all their portable assets, considering the most valuable combination. One of the two companies would receive a decent payout on their claim, offsetting any discomfort they had on paying the premium, while the other…. yes, underinsured, out of pocket, and now underprepared for future conference presentations.
• Stock and contents: In the underinsurance story, we’re separating stock and contents from property and portable equipment as it’s an insurance policy in its own right – especially if you’re a wholesaler or retailer (including online) and stock is your primary focus and concern. While for most business owners, determining stock levels is something that should almost come as second nature, the continuing global supply chain interruptions mean that many people are increasing their product and parts orders, so they’re not left short. And this makes for a sound business decision… unless an incident wipes out all your stock and your insurance hasn’t been correctly adjusted for the changes you’ve experienced throughout the year. Again, this all hinges on declaring the full value of your required cover and making sure that if it fluctuates, your policy reflects this.

How to avoid being underinsured

For any buildings, or tenants improvements, it’s advisable to get a professional and regular reinstatement cost assessment (RCA). This may be included in your insurance policy or as an extra, but having this carried out means that if something happens, the sums add up, and it can cost as little as £99 + VAT.

Then there are your policy limits. Bearing in mind all the guidance we’ve shared, are these limits as high as they need to be? And is all your stock and equipment properly valued and insured? 

Consider every tangible business asset you own and then get it covered. Does your insurance allow for your planned business growth? If you're successful, then your insurance policies need to keep pace with you!

Underinsurance can be avoided. Taking the time to review your policies and being realistic about any area that is uncovered may just be the saviour for your business in extreme or unwanted circumstances. It may not just be a roof blowing off that leaves your business exposed.

If you’d like to discuss any aspect of underinsurance, or find out whether your business policies are as robust as they should be, get in touch with one of our specialists today at [email protected], or learn more here.