Guide to Avoiding Underinsurance

What are the consequences of underinsurance?

In the best case yet highly unlikely scenario, nothing happens - your business runs smoothly with no issues, and you never need to make a claim. But even the best-run businesses can face unpredicted problems such as flash flooding, fire, burglary, and sickness, so it’s likely that you will need to make a claim at some point. But if you’re underinsured, your policy may not operate as intended, meaning higher costs for you and your business.

How does underinsurance happen?

There are several ways underinsurance can happen to policyholders.

Using an online calculator or simply making your best guess at a building’s valuation means that you may be insuring the property for less than its actual worth.

Many customers are unaware how the insurance principle of 'average' works and how it affects the value of a future claim. Any shortfall in a buildings sum insured will be reflected in a proportionate shortfall in claim settlement in the event of an insurable loss. In simple terms, if your declared sum insured is only 50% of the true value of all the property, then insurers may only pay 50% of your total material damage claim.

Most policies have an index-linking clause which helps policy holders keep up with inflation. By automatically increasing your sum insured, your insurance will be maintained at a level where 'average' should not apply. However, this cannot be wholly relied upon for a number of reasons. Levels would be compounded if an under-valued sum insured is declared in the first place and this process of index-linking does not take into account improvements or extensions made to the property.

It is a misconception that the sum insured is the same as market value - there is no correlation between the two. Neither should it be based on developers' costs; most definitions include the rebuilding costs plus any additional costs such as architects' fees and demolition costs.

It is very difficult to accurately calculate the rebuilding costs of a property as factors such as size, age, type of property, location, whether the building is "listed", of an unusual design, a new build and construction details will impact a reinstatement valuation.

Business interruption should also be considered. If it takes longer than the maximum indemnity period set out in the policy for the business to recover, the business will stop receiving claim payments once the set period expires.

How can I avoid underinsurance?

Here are our tips on making sure you avoid underinsurance when taking out a policy:

1. Get an expert valuation. Don’t use general market prices or online calculators to get the value of your property - these are likely to be inaccurate, and may not include unique features or existing property damage which could impact the valuation. Some aspects of a building’s reinstatement might attract VAT while others might not, and the position can vary depending on each organisation’s tax arrangements.

2. Understand the “condition of average” clause, which is typically included in property insurance policy wordings. When underinsurance is present, this condition enables claims settlements to still be made under the policy, albeit reduced in proportion to the level of underinsurance.

3. Don’t forget the contents. While small items may seem insignificant when considering your policy, it is important to accurately value and include them when making a decision. Small items can add up quickly, and it’s worth keeping an up-to-date inventory of all the items you wish to insure to make your valuation go as smoothly as possible.

4. Remember stock levels. If you are a business that relies on Christmas trading, your stock levels may be lower in summer - so if you take out a policy in July, you must remember to account for the maximum stock you store, rather than the current amount of stock. It’s also worth considering the nature of the stock itself - do you stock higher-value items in December compared to July? If so, your policy will need to be adjusted to reflect this.

5. Review your policy regularly. Property values fluctuate and so it may happen that the insurance you took out five years before may now not be sufficient cover. Most professional surveyors recommend conducting a full valuation every three years with desktop appraisals in-between to make sure you are adequately covered. You should also consider adjusting your policy when you make changes to the business. If you get new machinery or technology in the building, that can have a significant effect on the level of cover you will require. Discuss the changes with your insurer before you go ahead with these changes so you aren’t caught by surprise later.

Care and business insurance from Towergate

Make sure you speak to us to carefully assess your needs so you can avoid underinsurance. Visit our care and medical insurance hub to learn more about our care insurance products.

For other business areas please visit our business insurance hub.

This is a marketing article from Towergate.