The 'Underinsurance' debate
Posted on 23rd March 2022 at 08:40
What do we know about ‘Underinsurance’?
Put simply, ‘Underinsurance’ is when a policyholder has insured a risk for less than its actual replacement or reinstatement value. For example, insuring your building for less than its actual rebuild cost. In the event of loss, insurers will often appoint an independent professional Loss Adjuster to handle the claim and ensure it is correctly insured.
What happens when you a found to be ‘Underinsured’
Insurers apply ‘Average’, meaning any claim payment is sufficiently reduced depending on the level of underinsurance a policyholder is deemed to be. For example, if you insure your building for £500,000, when the actual rebuild cost is £1m, you are 50% ‘Underinsured’ and so any claim payment will be reduced by the same % amount. Calculation below –
÷ x 100 = 50%
Why do insurers apply ‘Underinsurance’?
You would be forgiven in thinking because it was just another ploy to make more money, but in fact it is to ensure a risk is insured for the full amount and a sufficient premium is paid. When a policyholder ‘underinsures’, they are paying an incorrect premium and so they are penalised for this short-term saving and risk they take.
The impacts of ‘Underinsurance’
Not only will you receive a short fall in any claim payment which will be insufficient to rebuild or replace the damaged risk in question, but you can also expect a delay as these claims often take longer to deal with, which can be detrimental to a business fighting for survival in the time of a crisis.
What can you be doing to reduce the risk of ‘Underinsurance’?
Here are a few steps that you can take to minimise the risk -
Carefully assess your Sums Insured and ensure your account for the significant recent increases in building materials, labour costs and skill shortages since Britain exited the EU.
Get a RICS valuation done to ensure that your assets are insured correctly on a full loss value basis. Please note that these will often not include VAT, so if you are an individual or not VAT registered business, to factor this in when setting your Sum Insured.
Ensure that your policies are index linked to ensure they allow for yearly inflationary increases. Be aware, this is only effective when applied to an accurate Sum Insured in the first place, so if in doubt get a professional valuation done which they will recommend having done circa every 3yrs.
Prevention is better than cure, so look to mitigate the risk of loss by ensuring good risk management practices are in place, any insurer’s risk improvements have been completed, and any ongoing risk improvements are continued to be reviewed e.g. waste removal, housekeeping, security practices and property maintenance.
A lot of what we have discussed relates to Buildings and Contents, but a major area where we see ‘Underinsurance’ applied and is on Business Interruption payments. Ensure your calculations are correct, set over a sufficient indemnity period and importantly on the correct basis. A common mistake for those businesses that insure on a ‘Gross Profit’ basis is using the same accounting amount, but this takes a different meaning in insurance. Guidance notes on this are clearly explained by Allianz.
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