Under-insurance occurs when you don’t have enough insurance, or for example the amount insured is insufficient to cover possible losses. For example the costs of rebuilding your business premises may be more than originally declared or you may have incorrectly totalled the sum of your stock and contents.
Under-insurance can lead to disastrous consequences down the line, with inadequate insurance cover held by the policyholder potentially resulting in economic losses, since the claim would exceed the maximum amount that can be paid out by the insurance policy. According to BPP 80% of properties are under-insured and 40% of businesses lack adequate business continuity cover. For small businesses in particular this can be troublesome, as small businesses tend to be more susceptible to going out of business as a result of a claim.
Increasing your insurance cover to a level that’s adequate for your business won’t cost the Earth, and you’ll be better for it in the long run, with the true cost of under insurance only ever felt when you need to make a claim.
Let’s face it; the potential for a slightly lower premium is far outweighed by the potential loss arising from a claim which involved under-insurance. Under-insuring simply doesn’t make sense for any business.
If you own your own business premises then that is likely to be one of your most valuable assets, probably the most valuable. Your business may also use equipment that is vital to the work you do. A tradesman needs tools and a shop needs stock so think, insuring these for less than it would cost to replace them or rebuild makes about as much sense as trying to insure a Ferrari at the price of a Skoda.
You might get away with it initially but at some stage the gap in cover is going to come back to haunt you.
If you have significantly under-insured your property, contents or stock your insurer would be within their rights to pay only part of any potential loss as you’ve only insured for part of the property’s worth.
Common causes of under-insurance
• Difficulties with estimating what it costs to rebuild a property
• Your insurance policy may be old (more than 3 years) and you may not have updated the level of cover needed
• You may have completed renovations which increase the value of your home
• Rolling over insured sums year on year, without addressing economic and business factors
• Underestimating the time it would take to recover following some form of interruption with business interruption cover
• Making erroneous assumptions regarding the necessary sums to be insured
• Not keeping sums insured under review from year to year
• Not taking into consideration the fact that accounting and business interruption definitions for gross profit vary
• Willingness to buy insufficient cover and ‘take a risk’
• Underestimating the costs for rebuilding the property, not keeping informed of rebuilding costs. Some cities have seen double digit inflation in that respect. Price of labour, materials and other costs should be taken into account.
• Not considering whether sums insured at the start of the policy will be enough during the policy’s entire life.
How to prevent under-insurance
Most people only read their policy when they need to make a claim. Unfortunately, by that time it’s often too late. Check your policy now to see how much your insurer will pay and under what circumstances and get to grips with what might lead to your insurer rejecting a claim. When working out how much cover you need, consider the worst happening, for example, a fire completely destroying your place of business.
The under-insurance checklist
1. Read and make sure you understand your Terms of Policy (ToP) and policy documents.
2. Identify the types of risks you are exposed to, the likelihood of these risks occurring and their potential impact. Councils and emergency service authorities can help you identify risk in your area and outline local plans and recommendations for each risk.
3. Re-asses your sums insured regularly, the sum you have insured now may no longer be adequate in 6 months time.
4. Have you rolled over sums year on year? Consider how your business has grown, shrunk or changed over time.
5. Have you considered the conditions and limitations on the policy? You’ll find these in the Warranties section of your policy documents.
What happens In the event of a claim if you’re under-insured?
In the event of a claim, most people will have one of the following terms within their policy documentation wording; “Subject to Average” and / or “Proportionate Remedies”. These clauses are designed to prevent false claims being made and help identify fraud. To help, The Insurance Octopus has broken down a brief summary of what these clauses mean, should you find yourself under-insured and in the middle of a claim.
Proportionate Remedies: is an action that an insurer can take when a policy holder fails to take reasonable care.
The Insurance Act 2015 (see link below) means insurers can take a proportionate approach in the event of a claim, rather than not paying any compensation at all. In essence the insurer can reduce its claim settlement amount. For example, had the insurer known the correct information regarding the risks they could have increased the premium by 20%, therefore giving them the right to reduce the final settlement figure by 20%. Had the policy holder provided the correct information of the insured asset, the insurer would have paid out in full.
Subject to Average: The term ‘subject to average’ (AKA average clause) means that if the sum insured at the time of the claim is less than the actual value of the insured asset or item, the insurers have the right to reduce the final settlement figure by a percentage, subject to the value of the asset against the amount insured. For example, you under-insure your asset by 50%, insurers then have the right to reduce the final claims payment by 50%.
In the event of a policy holder being determined to have deliberately and recklessly provided incorrect information, or misleading facts, the claim may be rejected entirely and / or could result in the policy being cancelled.
The Insurance Act 2015
Importance of getting your sums right
Calculate Business Interruption Insurance
Calculate sum of buildings cover
Calculate stock and contents
How much are your business equipment, Plant and tools really worth?