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 organisation. Common areas of underinsurance are typically property, stock and contents, plant & equipment, and business interruption.
How underinsurance occurs?
There are a number of reasons a policyholder may be underinsured. In many cases, it happens when valuations are out of date, roughly estimated, or incorrectly calculated. In today’s current business environment, inflation can also lead to underinsurance by causing a mismatch between the rising costs of asset replacement or repair and the static coverage limits in insurance policies, ultimately leaving policyholders financially vulnerable in the event of a claim. It can also be caused by insufficient limits in the policy.
In addition, business interruption often causes underinsurance when a policy's coverage and financial projections fall short of the actual income loss during an extended interruption. Delays with acquiring materials, planning procedures and neglecting specific scenarios or supplemental expenses can also contribute, as can having insufficient policy indemnity limits.
While underinsurance may be due to an oversight by a policyholder, it may also reflect action taken by the policyholder to reduce their premium by not declaring their sums insured accurately. Doing this not only increases the risk of financial loss, it can also void insurance cover altogether.
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. The 'average clause’ can be relevant to various types of property insurance, which may encompass coverage for buildings, contents, plants, machinery, and business interruption. The applicability of the 'average clause' is contingent on the specific terms and conditions outlined in your insurance policy.
For example, if your property insurance coverage falls short of the total reinstatement cost, and you need to file a claim, the pay-out may not fully meet your needs, regardless of the claim's size. This is because the percentage you are underinsured by can be deducted from your pay-out, under the ‘average clause’ in the policy.
According to recent industry research conducted by Charterfields1:
88% of locations surveyed were underinsured
36% of locations surveyed showed building values underinsured by more than 50%
80% of locations surveyed showed plant and equipment were underinsured
40% of locations surveyed showed plant and equipment values underinsured by more than 50%
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:
- Significant business interruption and a negative impact on your ability to function as an organisation.
- Prolonged unavailability of buildings, machinery or plant.
- Complex and extended negotiations with insurers, resulting in extended rebuild times and drained management resources.
- Lack of funds to complete the rebuild or the requirement to borrow on already stretched budgets.
- Exposure to potential legal action for inadequate levels of cover from lenders and leaseholders.
Can Gallagher help?
Gallagher is keen to work with you to address any potential underinsurance problem and urgently advises all businesses to undertake a property valuation to ensure that, in the event of making a claim, you have adequate insurance in place.
Please contact us if you wish to find out more about the availability of the Gallagher valuation service via the details below: