What is underinsurance and what are the risks?
Underinsurance is where, in the event of a claim, the protection you have bought is not adequate to satisfy your business requirements. Underinsurance is likely to result from insuring assets at incorrect values or setting cover limits too low.
What happens if I’m underinsured?
In the best-case scenario, nothing happens, your business runs smoothly with no issues and you never need to make a claim. However, even the best-run businesses can face unexpected problems, such as a fire, burglary, or flooding and it’s likely that you may need to make a claim on your insurance at some point.
The worst-case scenario under the remedies within the Insurance Act 2015, may be that your insurers consider that the declared rebuilding sum insured, represented a deliberate or reckless breach and would be within their rights to void the policy altogether, with no return of premium. Basically, you would have no insurance and no ability to make a claim with no refund.
If you are underinsured, it means that your assets are valued and insured at less than their current rebuilding/reinstatement cost (at today’s prices), leaving your company with inadequate protection. Therefore, in the event of a claim, you would receive a reduced insurance payout that could have a negative impact on your company.
How does underinsurance happen?
Under-insurance can happen to policyholders in many ways.
Referring to any online calculators or actually making your best guess at the value of a house, means that the land can be protected for less than its true worth. If you are using a tool such as the ABI Public Restore Calculator, using an online calculator is not necessarily a bad thing.
BCIS has been commissioned by the Association of British Insurers (ABI) to provide general advice to help you verify the appropriateness of your insured number. The Building Cost Information Service (BCIS) of the Royal Institution of Chartered Surveyors (RICS) produces a range of detailed guidance on the cost of rebuilding houses and flats.
Many consumers are unaware of how the insurance principle of ‘average’ works and how the value of a potential claim is affected. Any deficiency in the insured building amount would be expressed in a proportionate deficiency in the settlement of claims in the event of an insurable loss. For instance, if the building is covered for £ 1,000,000, but only insured for £ 500,000, the amount payable would be decreased by 50 percent because 50 percent of the building is underinsured.
Many policies have an index-linking provision that helps policyholders keep up with inflation by the amount insured annually, automatically in line with different indices. This should ensure that your insured amounts are kept at a level where there should be no ‘average’. The average clause is typically found in commercial property insurance clauses.
This presupposes; however, that the basic values are right in the first place. The consequence of the insured values would be compounded if the insured amount were set too low at the outset. Your reconstruction costs should also be reviewed annually to take into account improvements or extensions made to the property.
It is a misconception that the sum insured is the same as market value, there is no correlation between the two. Nor should it necessarily be based on new build developers’ costs.
Your insured building total should also cover the cost of demolition, debris disposal, site clearing, architect, surveyor and other professional fees. Additionally, don’t forget to add in the expense of gates, fences or car parks into your estimates.
What factors affect rebuilding cost and can cause underinsurance?
It is very difficult to accurately calculate the rebuilding costs of a property as a variety of factors need to be considered:
- Type of property – unusual or specialist design?
- Construction and materials
- Age and if it is ‘listed’
- Your VAT status
What else should be considered when arranging buildings insurance?
- Loss of rent
- Alternative accommodation
- Business interruption
- Increased and additional costs of working
Homeowners: If you are letting your property, you need to cover your future loss of rent as a result of a major loss or damage. Importantly, you should consider the maximum time that is likely to be needed to restore the house. It could be anything from 12, 18, 24, 36 months or longer. Ask your consultant for guidance.
Businesses (manufacturers, wholesalers, warehouses, etc.) should consider the possible disruption caused to their business by the duration of the restoration phase and the eventual recovery of your business, to the same level as before the damage occurred. In the worst-case situation, you will not be able to exchange until the property has been restored.
During this time, you may experience a complete or severe reduction in income and may also have lost customers. How are you going to pay the bills and continue the overheads? How long would it take you to get your company back on track? You should negotiate this recovery time with us in order to assess the appropriate indemnity duration for you.
This is critical as claims payments will end after the indemnity period has been met.
How can I avoid underinsurance?
Here are our tips on making sure you avoid underinsurance when taking out a policy:
- Get an expert valuation.
- Don’t use general market prices.
- Take care when using online calculators to get the value of your property – some of these may be inaccurate and may not include unique features or existing property damage, which could impact the valuation.
- Check the VAT status. Some aspects of a building’s reinstatement might attract VAT while others might not and the position can vary depending on each organisation’s tax arrangements.
- Consider commercial/residential, new or refurbishment.
- Average clause. Understand how the “condition of average” clause applies typically included in property insurance policy wordings.
- Valuation of material: don’t forget that the contents should be covered for their new replacement value, and the value should be adequate to cover all of your content. You must not omit items and insure everything: while small items can seem trivial, it is crucial to value them accurately and include them when making a decision. They can add up easily, and it’s worth maintaining an up-to-date list of all products required, to ensure that your valuation runs as smoothly as possible. We recommend that you make a list room-by-room.
- Stock insurance: if you keep stock, this should be covered for the cost of replacing stock and not at the price at which you are selling. A number of industries are seasonal. The school clothing shop will peak in the summer months, while several shops will need seasonal increases during the Christmas or Easter seasons. You must take into account the maximum stock amounts of your property at any time, and not the value that might be present as you arrange for insurance coverage.
- Review values at risk regularly. We recommend that buildings are professionally re-valued for rebuilding costs at least every three years. Property values fluctuate and so it may happen that the insurance you took out five years ago may now not be sufficient cover.
- Business changes. You should also consider adjusting your policy when you make changes to the business. If you get new machinery or technology in the building, that can have a significant effect on the level of cover you will require. Discuss the changes with your insurer before you go ahead with cover, to ensure you aren’t caught by surprise later.
Ensure your business interruption insurance is adequate
Your business interruption insurance not only needs to cover your continuing expenses and net profit (even if you may not be operating due to insured damage), but also to take into account the projection of how your sales and income are likely to rise during the time when you are unable to trade and when your business is recovering. Ensure that you are adequately insured to cover future plans and development.
When choosing your indemnity duration, this must be of ample time to allow your turnover to recover to at least the same level as you were at the time of the incident. An approximate 43% of business interruption insurance plans are thought to be under-insured by more than 50% (as stated by the Chartered Institute of Loss Adjusters*), so it is important to make sure that you are prepared for every eventuality.
It is also important to note how long you are going to need coverage, considering all of these variables. Think about how the business has changed and what it would cost to repair every year.
Ensuring your property is not underinsured
Under-insurance risks also apply to the replacement of buildings, where the costs relate not only to the restoration of the property itself, but also to a consequential disruption of the business when the building is being replaced. Remember to think about this:
- Costs for planning, permissions, site clearance, digging, construction, fit out – every step.
- The fact you will have to pay for alternative premises in the meantime.
- How long it will take for your turnover to recover once you have reopened.
- Lease, rent, rates and facilities outgoing and still in your name.
- Insuring the property for the build costs, not the market value.
- Any extensions, changes or extra buildings which could affect your sums insured.
- If you have rented a property, any tenants’ improvements you have made for which you are responsible.
Underinsurance can be a costly problem