Commercial property owners beware: when your property is insured for only a fraction of its current value, you are setting yourself up for a major financial headache. That was the unfortunate situation faced by a business owner in this case study, whose property was severely damaged in a storm.

The true consequences of underinsurance became evident as the owner attempted to lodge a claim. With only a quarter of the property value covered, the financial burden of repairing the damaged asset fell almost entirely on the owner's shoulders.

This real-life scenario highlights the importance of understanding the risks and financial impact associated with underinsurance.

Factors contributing to underinsurance

The property in question had been left vacant and the owner failed to adjust its insured value over the years. At the time of the storm damage, the property was insured for just $1 million, a fraction of its current estimated replacement cost of $4,460,000, as confirmed by a quantity surveyor in an independent valuation report.

The owner commissioned a reinstatement valuation to determine the cost of repairing their damaged property. The report established the repair cost at $461,000, with $21,500 of that amount allocated to removal of debris, which was covered as a benefit under the insurance policy and immediately paid in full by the insurer.

After subtracting the removal of debris cost, the repair bill amounted to $439,500. However, because the property owner was underinsured, their claim payment was subject to the co-insurance clause under the terms of their insurance policy. The insured value of the property was only a quarter of its estimated replacement cost, leaving the property owner with a significant underinsurance gap.

How the incremental effect of underinsurance cascades in a claim

The co-insurance clause in property insurance policies stipulates that the insured party must carry insurance coverage that meets a specified percentage of the property's total current value. Failure to meet this requirement results in t he insurer only paying out a percentage of the claim, proportional to the percentage of the property's value that was insured.

In this case, the property owner's insurance policy allowed for a variation of insured value to actual property value of 80%, but the insured property value was only about 25% of its actual current value.

The insurer will use the following formula under the co-insurance clause to reduce the amount it will pay for a loss. They do this to protect themselves against clients who intentionally devalue their property or assets in order to pay less premium.

Underinsurance in Action Storm Damage Pain for a Commercial Property

Using this formula, the property owners insurance claim payment was calculated as follows:

Insured Value of the property $1,000,000
Current Value of the property $4,460,000
Co-insurance Provision: 80%
Loss Amount $439,500
Claim Payout $123,178

The application of the co-insurance clause effectively reduced the claim payment to just $123,178 from repair costs of $439,500.

This left the property owner significantly out of pocket and they were forced to cover the underinsurance shortfall of $316,322!

If they had kept their insured values up to date, the insurer would not have applied the co-insurance clause and the owner would have been entitled to a much more substantial claim settlement.

The value of professional advice in avoiding underinsurance

Undertaking a professional insurance valuation for commercial property assets will help insured values remain accurate and we recommend that values are reviewed annually, particularly in the current economic climate where inflation is rife. Insured values must be based on replacement costs at current prices, not bank or real estate valuations, or purchase receipts for items subject to depreciation.

Involving an insurance broker who understands your industry sector and the risks that are particular to your business will help you ensure you have the cover you need. We're here to help. Connect with one of our experts who can help you organise a professional insurance valuation and address underinsurance today.



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