Understanding underinsurance

The last thing you want to hear when you claim is that your insurance won’t cover your total loss. Or that your insurer is declining to pay the full value of your claim.

But either can be the very real and damaging consequences of being underinsured.

What is underinsurance?

Underinsurance rears its troublesome head when your level of cover is less than a claim's potential total value. The difference between the two means the person or business claiming is out of pocket from the get-go.

So, say you insure your office contents for £40,000 but, after a burglary, it turns out replacing all your kit will cost at least £50,000. You're down £10,000 already. Ouch.

Law of averages

Then there’s the ‘average rule’ insurers use to calculate claims. It applies to some (but not all) property and business interruption policies. And it means if you’re underinsured, they can reduce the amount they pay you by the same proportion you're underinsured.

In this case, that’s £40,000 worth of equipment cover minus 20% (£8,000) underinsured, so a total payout of only £32,000….£18,000 shy of the true replacement cost. Double ouch.

What causes property underinsurance?

Underinsurance can happen when you undervalue the cost of replacing all your kit. Or when you miss something off the list – like carpets, furniture, fixtures, fittings, or hired equipment.

It can also happen when you value your contents at the price you originally paid for them. Remember, your level of cover should be enough to repair or replace all your equipment if it was wiped out today – from your smallest stapler to your most expensive tech. So, sifting through old receipts won’t help.

Better, too, to overestimate how much your stuff's worth than find yourself short. If your cover includes stock, you might want wiggle room for seasonal stock increases, like the pre-Christmas rush. Same goes for working out the potential replacement value for any new equipment you buy.

Once you’ve worked out the cost of everything – and we mean everything – you can choose the most appropriate level of cover for your business. Then you’ll have the best chance of making sure you’re not left underinsured and having to make up the shortfall if you ever have to claim.

How else can I be underinsured?

Underinsurance goes beyond equipment. In fact, you can be underinsured for any type of insurance in terms of simply not having enough cover. But here’s where we see it most often:

• Buildings/ Commercial property: you only insure a building for its market value, not the re-build cost – which can be much more. With recent rises in the price of building materials and labour, underinsurance is a big problem here. It’s estimated around 46% of UK commercial properties are underinsured.
• Professional indemnity (PI): you don't have enough cover for the most expensive mistake you could make. Or for if a client sues you for the total value of a failed project – not just your part in it. You should also account for legal costs. They can run into many £tens (or even £hundreds) of thousands if a claim is complicated or drawn out. Here's a handy guide to working out how much PI cover you might need.
• Business interruption: your workplace is out of action, but your cover isn’t enough to compensate you for your lost income and additional expenses in the time it takes you to get back on your feet.

What next?

Underinsurance can leave you seriously on the back foot. So it's important to regularly review your cover and make sure you have enough – and not always just before your annual renewal. Your circumstances can change considerably in the twelve months between buying insurance and renewing it, and your cover needs to keep pace.

We'd advise going through your insurance portfolio on a regular basis and taking a realistic view on whether you have enough to allow for a worst-case scenario. Take your time working it out – better yet, keep a spreadsheet which you can update.

One last tip. If you’re calculating the rebuild cost of a commercial property you own, it’s best to get a surveyor’s quote or speak to your mortgage lender. The Building Cost Information Service (BCIS) has a handy online calculator you can also use.

A risk not worth taking

Any pains you take when working out how much cover you should have are worth it. Because the consequences of underinsurance can be serious in two ways: leaving you unable to claim for your full loss, and making you susceptible to the average rule, reducing your claim further.

That's a double whammy that can seriously affect your finances.

Read more on how not to be underinsured. Or call our team up 0345 222 5391 with any questions you'd like answered. We’ll be happy to help.

Image used under license from Shutterstock.