What is underinsurance and how can I avoid it?
Underinsurance is a perennial problem affecting many organisations. It occurs when insurance is in place, but the amount insured is not sufficient to cover the amount actually at risk. Underinsurance can occur in different areas but is most commonly found when insuring buildings, contents or equipment and business interruption.
According to a leading valuations company, 75% of the 4800 UK properties it surveyed in 2022 were underinsured, which were on average underinsured by 53%. Although some parts of the market are better educated on the risk of underinsurance, particularly commercial properties have always had this problem. Setting an accurate declared value has been made even more difficult with recent claims inflation caused by the increase in cost of rebuilding as a result of Brexit and pandemic related supply chain issues.
Aside from the scale of the problem, of major concern is the depth of the issue on individual properties. On average, an underinsured building could be undervalued on the insurance policy by 45%. This means a building which would cost £500,000 to rebuild (e.g. after a fire), is incorrectly insured – for just £275,000.
The same issue can apply to insurance for contents and equipment. Often cover is arranged and then left. As equipment is updated or replaced and new contents are purchased, the insurance covering these assets is left unchanged and becomes inadequate to cover the full replacement value.
Business interruption covers extra costs to continue operations or loss of revenue you suffer in the event of damage to your premises. For example, a fire at your centre means you have to rent expensive alternative space for 18 months. When arranging business interruption insurance, organisations are often left underinsured with indemnity periods that are too short to cover them, or sums insured that are inadequate.
Some organisations are aware they are underinsured but know it’s unlikely their property or contents will ever be completely destroyed, even in the event of a serious claim. For this reason, they insure for less than the ‘full rebuild/ replacement’ amount, reasoning they don’t need the ‘full’ cover. There is a serious problem with this approach as many insurance policies have an ‘average’ clause, designed to ensure buildings and contents are insured for their full value.
In simple terms, the average clause means if you only insure 50% of the value of your building, you will only receive a 50% payout on any claim – regardless of its size. Take our example of the £500,000 building, underinsured by 45%. If they suffer a flood and need to make a claim for £40,000, the insurer will be entitled to reduce the payout by 45% (in line with their underinsurance) to £22,000. Some average clauses are even more stringent; by stating that once a building is under-insured by a certain amount the insurer can void the policy and refuse to pay any claims, regardless of size.
Even if a policy has no average clause, the insurer can take similar action under the provision of The Insurance Act, proportionally reducing a claim payout. In the worst cases, an insurer can decide the underinsurance is so bad it represents a deliberate or reckless breach by the policyholder. In such scenarios, the insurer can void the policy without paying any claims.
You want your insurance to respond as you’d expect when you need to claim. In the event of a serious incident, you’ll need to rely on your insurance for financial stability. It’s critical your rebuild cost and sums insured are accurate so you are not at risk of a reduced payout, or worse a voided policy, at a time when you really need your insurance to protect you.
Fortunately, establishing accurate sums insured can be done fairly easily and without substantial cost. For contents and equipment, you should maintain an accurate asset register with the current replacement values (as new) for the entirety of your contents. To establish adequate limits of indemnity for your business interruption cover, take advice from an independent charity insurance specialist. This advice is usually included at no extra cost within the service that a broker will provide you.
You will want to assess any potential effect that damage to your premises will have on your income, as well as considering what additional expenses you would face in a scenario where you needed to hire additional premises. A specialist can help you to consider a range of factors when setting an indemnity period. Depending on the complexity of your activities, this will need to take into consideration the likely time to rebuild your premises following a claim, the availability of similar premises locally and the impact of a claim on your revenue and ability to deliver services.
If insuring a building, the best way to ensure you are insured for the right amount is to have an ‘insurance rebuild cost survey’ carried out by a professional surveyor. Having a rebuild cost survey periodically is vital, but these surveys have traditionally been costly and time consuming. Fortunately, new technology utilised by several specialist firms, allows surveyors to produce a bespoke, accurate rebuild cost assessment report without needing to visit your premises.
- Case study: charity owned building
In discussions with a charity who own a community building, we asked how confident they were in the accuracy of their rebuild cost, which was set at £827,000. Upon investigation, they found the last survey had been carried out nearly 10 years ago. After talking through the risk of underinsurance they decided it was prudent to have a remote rebuild cost assessment.The survey was carried out and the assessment produced within 48 hours, giving a comprehensive breakdown by building of the accurate rebuild cost, with rationale for how this figure had been calculated. The correct rebuild cost was £1,343,000, meaning the building was underinsured by 38%.Had the organisation made a claim on their buildings insurance with the previous sum insured they would have faced having their pay out reduced by around 40%. Fortunately the survey revealed the inadequacy of the sum insured, giving the charity the knowledge to insure for the correct amount.“We are relieved that we now have an accurate picture of the rebuild costs and are properly insured. This service helped us see how out of date our rebuild costs were and how underinsured we would have been if a disaster had occurred. We are grateful the reassessment was done so efficiently.” Access Charity Client
In summary, pay close attention to the sums insured and limits of indemnity when arranging insurance for your organisation. It can be tempting to try and cut costs in uncertain times, but you want to ensure the cover you are buying gives you the protection you need. Access can help arrange a rebuild valuation survey through our partner RebuildCostAssessment at preferential rates (from £156). If you have questions or would value advice and help on working out the correct levels of cover, please contact one of our specialist advisors.