With inflation at an all-time high, some organisations may be unknowingly underinsured in areas such as property or business interruption. If your cover no longer reflects your sums insured, your business could be one of them.

Supply chain disruption and a shortage of skilled labour in the construction industry have seen building repair costs and delays to the completion of work increase significantly. This is having a knock-on effect on the cost of property damage claims, which can increase further in cases where repair works lead to prolonged business interruption.

While sums insured are usually automatically index-linked to inflation, this may not be enough to provide sufficient cover in the current climate, as it still may not factor in the total cost of completing a significant rebuild project.

What is underinsurance?

Underinsurance is when a policyholder has inadequate insurance cover for their needs. In the event of a claim on the policy, it could mean the claim amount exceeds the maximum limit that can be settled by the insurer. In many cases, underinsurance happens when valuations are out of date, roughly estimated or incorrectly calculated.

What can happen when a property is underinsured?

Your business premises may be your highest value asset, and integral to the smooth running of your day-to-day operations. And yet, many businesses have an element of underinsurance on their commercial properties, often due to letting their valuations become outdated or inaccurate.

If your buildings insurance doesn’t cover the total reinstatement cost, and you needed to make a claim, the pay-out may be insufficient—however large or small your claim amount. This is because the percentage you are underinsured by can be deducted from your pay-out, under the ‘average clause’ in the policy.

What is the average clause?

This is a clause in the insurance policy stating that the policyholder must bear a proportion of any loss if assets were insured for less than their full replacement value. If the insurer finds the business has taken out inadequate insurance, it can reduce the settlement by the same percentage the asset is underinsured.

Here is an example:

Consider a building with a current sum insured of £7.2 million.

A fire occurs which damages most, but not all, of the property. Insurers appoint loss adjusters and they calculate the true rebuilding cost of the property to be £9 million (in other words it was underinsured by 20%). The cost of the loss is calculated to be £5 million but once the insurer applies the average clause—the claim payment is reduced by the amount of underinsurance (20%) leaving the policyholder £1 million short of the full repair costs.

Business interruption—how can businesses predict the cover they might need?

A common insurance oversight for business interruption (BI) insurance is that the period of cover selected to protect the business financially turns out to be far shorter than the actual period of disruption. The rise in demand for building materials and labour has not only led to an increase in building costs but also longer delays in completing the works.

The problem is that some businesses are still setting their BI indemnity periods at as little as 12 months, which may not be enough in the event of a significant structural repair or rebuild. If your BI policy stops paying out before you are able to begin trading again, this could have serious consequences for your balance sheet.

How can a business reduce the risk of underinsurance?

In the property insurance example we have outlined above, the policyholder would likely have been adequately insured if they had carried out regular reinstatement cost assessments. This would have identified the underinsurance on which they could have acted. The Royal Institute of Chartered Surveyors (RICS) recommends that a reinstatement cost assessment is carried out every three years, or earlier should significant alterations be made to the insured property with an annual adjustment to reflect inflationary effects.i

Whether property, plant, stock or equipment, it is important that your insurance accurately reflects your sums insured and your business activities. So, if you have made any structural changes to your property, increased your stock levels, purchased new plant or even made changes to the way you do business, you should let your insurance broker know straight away.

Specialist services from Gallagher

One of the services we offer to our customers is an insurance review, to help ensure you have cover that is adequate for the needs of your business today—including a true reflection of your rebuild costs as well as your business interruption limits and indemnity periods.

We also offer surveys and valuations services whereby we can provide buildings replacement sum insured values through our partnership with a RICS-approved company. This may be especially important if you have not had a buildings valuation in recent years.

To find out more, please get in touch with us below.

  • Risk Management Team


Reinstatement Cost Assessment of Buildings, 3rd edition rics.org


The sole purpose of this article is to provide guidance on the issues covered. This article is not intended to give legal advice, and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and/or market practice in this area. We make no claims as to the completeness or accuracy of the information contained herein or in the links which were live at the date of publication. You should not act upon (or should refrain from acting upon) information in this publication without first seeking specific legal and/or specialist advice. Arthur J. Gallagher Insurance Brokers Limited accepts no liability for any inaccuracy, omission or mistake in this publication, nor will we be responsible for any loss which may be suffered as a result of any person relying on the information contained herein.