People often confuse a property's market value with its insurance value, but the two figures can be markedly different. The insurance value is what it would cost to rebuild, including materials, labour, and extra costs such as permits and associated fees.
For insurance to be effective, it’s essential that the coverage matches the specific needs of policyholders. Insuring assets for the wrong values or setting inadequate cover limits can result in underinsurance. This means that policies may not provide enough compensation following a loss, potentially placing an organisation's recovery at risk.
- 83% of properties in the UK, including those owned by charities, are underinsuredi.
- 86% of charitable organisations are worried about the effect of the increased cost of living on themii, while nearly 65% are worried about the higher cost of stock, equipment and suppliesiii.
- 1 in 10 small and medium-sized organisations say they would not survive if they had to pay up to £10,000 towards a claim that was not fully covered by insuranceiv.
What is underinsurance?
Property Underinsurance can happen when you arrange cover on a building using a rebuild value lower than the actual rebuild value when assessed by a professional loss adjuster. Here’s an example of how underinsurance can affect a claim payout:
| Insured rebuild cost | £1,000,000 |
| Actual rebuild cost | £2,000,000 |
| Underinsurance percentage | 50% |
| Fire claim | £300,000 |
| Settlement | £150,000 |
Improved technology has made it easier for insurers to assess underinsurance. Having adequate insurance for listed properties is essential, as a local council may insist you reinstate the property, even if you cannot recover funds from your insurer.
Over-insurance is the opposite; if you’re insuring a property for more than its rebuild value, you’re paying extra for no benefit.
What is causing property underinsurance?
Inflation is the primary reason for the underinsurance of UK properties. As the cost-of-living increases, so does the cost of rebuilding, leaving organisations at risk of becoming underinsured without knowing it.
The rising prices of materials are making building repairs more expensive. Construction materials have experienced the greatest price fluctuations in the 12 months to November 2023. Pipes and fittings have experienced the highest inflation rate at +23.8%v. Brick and blocks continue to see significant shortages; brick deliveries have dropped by 32%, and block deliveries fell by 24.6% compared to the previous year, and these shortages could continue into 2024.
Getting these materials and finding skilled workers takes longer and is more expensive today. If the insurance coverage for a property is determined by its value at the time of purchase or a previous valuation, it may fail to account for the increased rebuilding costs due to inflation. This leads to a disparity between the insurance payout and the actual cost of rebuilding, leaving the policyholder responsible for covering the shortfall. For buildings underinsurance, this could have a significant — and potentially catastrophic — impact on a charity.
How can charities manage underinsurance?
- Proper valuations to protect your property
Proper valuation of the property and assets is important. It affects both your payout and your premium. When it comes to insuring buildings, it’s essential to focus on the rebuilding cost rather than the market value, especially in scenarios like post-fire reconstruction. This includes expenses such as materials, labour, demolition, permits, and associated fees to ensure full coverage. - Adequate sums insured for stock Organisations should put emphasis on insuring the cost of stock rather than its potential profits. That means excluding reclaimable VAT and considering the maximum stock value at all stages of the organisation’s operation, from raw materials to finished goods. By doing so, organisations can ensure adequate insurance coverage for their specific needs and circumstances.
- Reviewing insurance policies
Organisations must review their insurance policies, particularly after making changes or improvements to the property, as its value may have increased. Underinsurance can lead to a reduction in claim payments due to the average clause applied by insurance companies. It’s important to choose an insurance policy that covers natural disasters, fire, theft, and other risks, while also considering the balance between premiums and coverage. You should also understand the deductible amount for fair claim settlements. Additional coverage options, like personal belongings or liability insurance, should also be considered. - Ensuring Business continuity With rising costs, like accommodation expenses after a loss and inflationary pressures, reinstatement is taking longer. It’s important for policyholders to assess the adequacy of their indemnity period. Ensuring that business interruption limits align with potential losses and the duration of insurance payouts is essential. Charities should consider factors like increased utility charges and rising costs of supplies and services. Reviewing coverage in areas such as cyber liability, legal and regulatory risks is also advisable to safeguard the organisation's operations.Insurance needs to adapt as organisations change over time. With inflation and supply chain issues, policies with a 12 or 24-month indemnity period must reassess coverage in these uncertain times. For instance, if an organisation suffers a loss at the end of a 24-month policy and takes 12 months to fully recover, it is 36 months after the initial coverage levels were set. To ensure adequate coverage, the sum insured should reflect both current and anticipated circumstances.
What is an 'average clause'?
When the insurance coverage is insufficient, the 'average clause' comes into play. It ensures that businesses will not get the full payment if they haven't paid the full premium. This means insurers reduce the payout based on how much the property is underinsured.
Example:
If your building’s rebuild value is estimated at £800,000, but your insurance policy only covers £660,000. Even if you experience a £20,000 loss, with the average clause in effect, your insurer might only payout £15,000 (75%), leaving you responsible for the remaining £5,000 (25%). This highlights the importance of insuring your property for its full rebuild cost to avoid being underinsured.
How can Gallagher help?
We’re here to protect your charity with adequate insurance coverage, helping to ensure you are safeguarded against unforeseen losses. We’ll check your insurance to find any gaps and create a policy that reflects your needs. We can provide you with a quote for a rebuild valuation from a RICS (Royal Institute of Chartered Surveyors) qualified surveyor, ensuring your property is accurately assessed for insurance purposes.
If you’d like to discuss your insurance programme or book a property valuation, please contact our team or call us on 0121 407 4101. We’re here to support you.