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.