ILC ARTICLE

Commercial underinsurance: the major loss is merciless

16th May 2019

Date: 16/05/17

Source:Inadequate insurance coverage could result in serious financial losses, and in some cases could cripple an organisation where the amount claimed exceeds the maximum that can be settled by the insurance policy.

Yet despite the clear risks, underinsurance remains a problem in the UK, and the below figures paint a compelling picture.

Research by The Building Cost Information Service demonstrates that UK commercial property underinsurance rates could be as high as 80% and that the sums insured regularly appear to trail valuations by 20%.

Similarly, research by the Chartered Institute of Loss Adjusters (CILA) found that business interruption policies – the key ones that get a business back on its feet after a major incident and claim – were underinsured by an average of 50%.

Below, we identify the risks and traps of underinsurance in your organisation – and then look at how to minimise it.

Property damage and business interruption insurance

The most obvious indicator is the inaccurate insured value of items such as premises and other infrastructure. This is usually caused by out-of-date, estimated or incorrect valuations and can also be caused by insufficient limits in the policy. Here’s a worked example.

• A commercial property has a rebuild value of £2 million but is insured for only £1.8 million: the underinsurance gap is 10%.
• Assume the costs for storm or fire damage come to £240,000; the insurer will then likely reduce that claim by a 10% gap – paying out only £216,000 and leaving a shortfall of £24,000 for which the policyholder is now liable.
• The proportionality remedy under the Insurance Act means some insurers may only charge any additional premium due had the original sum insured been correct. But remember, that is only certain insurers and not the whole industry.
• However with a deliberate or reckless case of underinsurance, an insurer may allege a failure by the policyholder to observe the new duty of fair presentation. They could then refuse to pay the claim in its entirety.

It is often the case that cover reviews, sums insured, policy limits and estimates can be left untouched over time, despite major changes like expanded premises, new equipment or a larger workforce. Your best defence is to consult an independent professional to audit your assets and pressure-test their values and replacement costs annually.

Tips for preventing underinsurance 

While the risk underinsurance poses can be hidden, the factors for identifying and removing it come down to embedded process, habit and repetition. Any audits or valuations made should be carried out by an independent professional. Consider the following:

• Think about the rebuild costs; your overall sum insured needs to be the most you would need to rebuild and replace from absolute scratch.
• Are the policy limits insufficient? Check them against the needs of your organisation.
• Update the new-for-old replacement of plant, assets and premises for your organisation annually.
• Set a realistic indemnity period within business interruption insurance that gives your organisation enough time to recover. Remember that many business interruption policies are written on a non-average basis and that makes the accuracy of the sum insured even more important. Your sum insured should reflect the anticipated business growth and not just past performance.
• An annual review of all relevant policies with your broker, based on your changing valuations, will ensure you have the most effective cover available. Don’t forget areas like employers’ liability, public liability and professional indemnity. As your circumstances change, so does your risk.
• Always check your insured sums have automatically been index-linked to inflation as your liabilities at rates for 2016 will differ from those in 2017.