The Hidden Risk of Underinsurance
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Are your current sums insured adequate? Events over the last few years mean that we are seeing inflation at levels many of us have not seen for a long time. If your sums insured do not represent the full value of the property you are insuring, you may not receive the full amount in the event of a claim.

We have seen the holiday park industry experience many obstacles over the past two years. Prices of caravans have continued to rise and new units have become increasingly difficult to source, as supply chain problems affect the supply of materials required to build them. This is only exacerbating the price issue.

Why is underinsurance happening?

In November 2022, UK Chancellor of the Exchequer Jeremy Hunt confirmed what many already knew: Britain is in a recession. Inflation is now in double-digits—remaining near a 40-year high—and the cost of living crisis, the war in Ukraine and soaring energy prices have compounded in a post-pandemic UK. Consequently, businesses are at greater risk of underinsurance than ever before.

The root of the property underinsurance problem is the rapid inflation in the cost of building materials. For example, the cost of cement increased by 18% between September 2021 and September 2022, with steel up by 13%,1 and the price of timber up by 35% year-on-year in 2021-2022.2

What is underinsurance?

Put simply, underinsurance is when a policyholder has inadequate insurance cover for their needs. In the event of a claim, this could mean a claim amount exceeding the maximum limit that can be settled by the insurance company. This could result in a shortfall for the policyholder, potentially leading to a serious financial loss for the business.

What can this mean for your insurance cover?

If you have hire fleet and sales stock insured on your park’s policy, it is important to understand the potential impact of the increased costs of replacement. It is your responsibility to ensure that your sums insured are adequate, otherwise, in the event of a claim, deductions may apply due to underinsurance. Similarly, if one of your park buildings needed to be repaired or rebuilt following an insured incident, underinsurance could leave you facing serious financial consequences.

Underinsurance in action—the ‘Average Clause’

The ‘Average Clause’ is a standard policy condition in UK property insurance policies. In its simplest form, the clause allows an insurer to reduce a claim payment proportionate to the amount of underinsurance present at the time of loss.

By way of example, consider a park clubhouse with a current sum insured of £1 million. A fire occurs, which damages most, but not all, of the property. Insurers appoint loss adjusters, and they calculate the property’s true rebuilding cost to be £1.2 million (in other words, it was underinsured by 20%). The cost of the loss is calculated to be £800,000. However, once the insurer applies the Average Clause, the claim payment is reduced by the amount of underinsurance (20%)—leaving the policyholder £160,000 short of the full repair costs.

What problems can underinsurance cause?

If a claim payment does not cover the full property repair/rebuild cost or reinstatement, it could mean funds may not be available to complete the rebuild. This may result in the following:

  • Negative impact on service delivery to your customers.
  • Prolonged unavailability of buildings, machinery or plant.
  • Complex and extended negotiations with insurers, resulting in extended rebuild times and drained management resources.
  • Requirement to borrow on already stretched budgets.
  • Exposure to potential legal action for inadequate levels of cover from lenders and leaseholders.
  • In the worst case scenario the business may never recover.

What are the common areas of underinsurance?

The most common reasons for underinsurance in holiday parks we see typically fall within the following areas:

Stock, hire fleet and contents: If you were to insure only part of the total value of your stock, hire fleet or contents on the basis that it is unlikely to suffer a 100% total loss of those items, you would be overlooking the fact that the total figure still needs to be known by an insurer. Policyholders may believe they can claim up to that limit, however, this is not necessarily the case. This is because the Average Clause of a policy allows insurers to pay a lot less if a policyholder has underestimated the declared value of stock/hire fleet/contents.

Claimants often assume the current or secondhand value will suffice in the event of a loss. You should check with your broker the basis of settlement i.e., reinstatement (new for old), or indemnity (market value). If you do not have new-for-old cover, your payout will likely be insufficient to replace the assets you are claiming for.

Buildings insurance: Buildings should be insured for reinstatement cost, i.e., the most you would need to rebuild and replace your park buildings from scratch. You will also need to make allowance for the following costs:

  • Architects, surveyors, legal and professional fees to rebuild or repair your buildings.
  • The cost of clearing debris, dismantling, demolishing, shoring up, propping up or supporting parts of your building which have been damaged.
  • Other costs necessary to keep to government or local authority requirements.
  • Costs incurred in the delivery and or re-siting of any insured building at the premises.

A valuation from the Royal Institution of Chartered Surveyors (RICS) is recommended to help you determine reinstatement cost.

Business interruption: It can be easy to underestimate how long it would take for your business to get up and running again after an insured event. Often, a period of cover is far shorter than the actual period of disruption, leaving a park owner with ongoing losses after the insurer stops paying. To work properly, your policy requires a thorough and up-to-date assessment of the interruption exposure. This should include a business continuity plan that represents a true picture of the time and resources you need to achieve pre-loss turnover levels.

Inflation: Insuring for an outdated purchase price can prevent replacement for that same cost. Consider mid-term fluctuations in material costs through inflation or market forces. Certain types of goods are more subject to market forces than others with some having the potential to increase in value significantly in a short space of time. Insured sums should ideally be automatically index-linked to inflation.

Insufficient insurance reviews: Failing to review historical sums insured at policy anniversary may lead to gaps in cover. Acquiring new plant and machinery, adding a new computer system, or increasing stock levels are not always quickly linked by customers to the need for an insurance conversation. It is best practice to undertake this annually in addition to discussing changes with your broker at your review meetings throughout the year.

How can you ensure all areas are covered?

We encourage you to regularly review your sums insured to take into account various changes and challenges that may affect your park, such as building work on-site, weather/climate-related risks, or an increase or decrease in stock. Use the key underinsurance risks we have outlined as a guide to help you assess whether your cover is adequate for each area of your business. If you have made significant changes to your assets, property, stock or business activities, let your broker know straight away—don’t wait until renewal.

Your customers should also be aware of the potential effect on their own insurance cover when replacing their caravan, so it’s important to have this conversation with them to help ensure they are adequately protected.

How Gallagher can help

Our specialist team can work closely with you to help ensure all aspects of your business are sufficiently covered. We can conduct an insurance review to identify any potential gaps in cover, and then tailor a policy to suit your park—with bespoke policy wording available to suit your specific requirements.

We also offer park surveys and valuations services whereby we can provide buildings replacement sum insured values through our partnership with an RICS-approved company (with valuation reports supplied within 14 days of the survey).

If you would like to find out more, call us on: 01452 801 700


Sources

1. Cost of concrete and fabricated structural steel from Monthly Statistics of Building Materials and Components, published by: Department for Business, Energy and Industrial Strategy, 2 November 2022.

2. Cost of timber from IBIS World Timber Price Index, 28 September 2022. All data unless otherwise stated is from research conducted by 3Gem, between 8 May and 16 May 2022, among 1,000 senior decision-makers in UK businesses.


Disclaimer

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.