Your guide to underinsurance

What does underinsurance mean?

Underinsurance, put simply, means your business risks are far greater than your policy covers. A building may only be worth £200,000 but rebuilding it could actually cost significantly more. You should be insured for the reinstatement value, not how much the building would be worth if you sold it. 

If you are underinsured at the point at which you make a claim, the condition of average will come into play. This is a rule that calculates what payment you will receive. 

The “average” means your insurer will pay only a certain percentage. This percentage is calculated as your Sum Insured (the amount you’re insured for) divided by the accurate valuation. The insurer will only pay that percentage of your claim, minus the policy excess. 

So let’s say you have insured a building for £500,000 yet the valuation stands at £750,000. 

500,000 is 66% of 750,000 – meaning the insurer will only pay 66% of any claim (minus the policy excess). The more underinsured you are, the more you’ll have to pay out yourself should you need to make a claim. 

How does underinsurance work?

If you do need to make a claim, and you’re found to be underinsured, you may find your insurer unwilling to pay the full claim amount – if at all. 

You can be underinsured for a number of different types of insurance:

• Buildings and Contents

You may think your building or property is worth a certain amount – but you may be surprised to learn that it’s worth a lot more once you start trying to buy it “as new”. Insurers want to know reinstatement and rebuild figures – not the amount you bought your property for. 

• Business Interruption

Think about your indemnity period – the length of time it would take for your business to get back on its feet. Most businesses will require two years to get back to their “normal” level of trading following a period of interruption. Make sure your policy will cover you for the amount of time you need, so you aren’t left underinsured should the worst case scenario happen. 

• Data or information

Physical copies of your data or vital business information are, quite literally, worth the paper they’re written on. You won’t be insured for what that data or information is worth. That’s why many insurance policies stipulate that businesses must keep separate copies of their important documents elsewhere (such as away from the business premises). 

Why are businesses underinsured?

There are a number of reasons as to why a business may be underinsured. Business may not be aware of specialist covers they need, such as cyber or terrorism insurance. They may assume their “standard” policy will cover them for incidents caused by these circumstances. Their policy may tell a different story. 

Some businesses may knowingly be underinsured to achieve a lower premium. This is, obviously, not advisable. Yet businesses who see premiums skyrocket may try to find sneaky routes to bring the cost down – potentially at the cost of their business, if the risk doesn’t pay off. There’s no winning scenario here. Insurers require you to make a fair presentation of risk for a reason. 

Or, simply, a business may miscalculate the cover they need. They may not take into account increases in gross profit, seasonal increases or reinstatement values. 

How to avoid underinsurance

Business owners shouldn’t be expected to be insurance experts. Understanding how to make a fair presentation of risk, and knowing what insurers need to know about, is a tricky and complex task. That’s why insurance brokers are trained and qualified to do the job effectively. 

When you work with an insurance broker, you can rest assured they’ll thoroughly get to know you and your business. They’ll analyse your risk portfolio, and help you to decide exactly how much you should be insured for. Then, if the “what if” does happen, you’re likely to be awarded the full sum of your claim. 

A broker may try to negotiate a “no average” clause on your policy. This means that an insurer cannot initiate a condition of average in the event of a claim. Nevertheless, businesses must ensure they provide a fair presentation of risk and should never try to deceive an insurer or knowingly underinsure. 

Underinsurance vs uninsured

Being underinsured doesn’t mean you’re uninsured completely. Your insurer may still pay out – you just won’t receive the full amount you need to rebuild your business if you’re underinsured. 

Being uninsured means you haven’t even explored the option of insurance with a broker or insurer. If an accident or incident happens, you won’t be covered at all – you’ll be left paying for every ramification yourself. 

Underinsurance means your insurer will penalise you for not adequately insuring your risk. You haven’t declared the full risk, and the full premium hasn’t been paid. So, no surprises, you won’t be provided with the full payout. 

Whilst being underinsured is significantly preferable to being uninsured altogether, you should always aim to have fully comprehensive insurance in place. 

Underinsurance case study

The situation

One of our clients is a wood manufacturing company. They had recently bought a new second hand machine for £50,000. Unfortunately, they did not realise that to buy the machine “as new” would have been £250,000. This amount needed to be declared to the insurer as, should the client need to make a claim, the insurer would value the machine at its “as new” price. 

The client had also miscalculated its Business Interruption gross profit. It needed to be calculated from the year ahead, including all staff wages, to ensure an accurate sum would be paid out in the event of a claim. Our client had declared the sum for the previous year and, taking into account business growth, it simply wouldn’t have been enough. 

Our solution

Fortunately we were able to help our client declare an accurate representation of their risk. The insurer now knew the “as new” value of the machine, and the manufacturer’s gross profit estimate. 

When a fire caused catastrophe less than six months later, our client was relieved to receive a full pay out from the insurer. Without our intervention, they would have been left significantly underinsured and would have had to foot the bill themselves. 

The conclusion

Brokers are invaluable to businesses. We get to know your business, assess your risk and analyse your policy. We find the best, comprehensive cover for an affordable premium. Peace of mind that, should the worst happen, the worst won’t really happen and you will be able to rebuild your business.