Business underinsurance – the risks and how to avoid them

Underinsurance is when the sums insured of a property, or asset, do not reflect actual replacement cost. Underinsurance can occur in any area of insurance, whether personal or commercial.

Here, we explore the risks of business underinsurance and what you should do to avoid the consequences.

• What is underinsurance in business?
• Why does business underinsurance happen?
• Underinsurance vs self-insurance
• Underinsurance vs inadequate cover
• How can businesses avoid being underinsured?

What is underinsurance in business?

It is the duty of the policy holder to set the sums insured of a building or asset. If this figure is lower than the true value of reinstatement or replacement, then it may fall foul of the ‘average’ clause. Whereby the insurer pays out a settlement lower than the claim value.

As an example, if a commercial building has a rebuild value of £400,000, with current material and labour costs, but carries a sums insured figure of £300,000 it is likely to have a 75% average clause value. If a claim is made for £50,000 the insurance company may only settle 75% of the claim. In this case, £37,500.

Most insurance policies include an 85% average clause value to allow for a margin of error. If the sum insured value is 85% adequate or higher, the average will not apply.

Why does business underinsurance happen?

There are a few reasons why underinsurance can occur. Primarily, however, the main reason is simply down to a mis-valuation by the policyholder.

Inaccurate valuations

If you haven’t recently (or ever) had your business premises or equipment properly valued, it’s a good idea to arrange to have this done. This will ensure that the sums insured on your policy are enough to cover the buildings and items listed.

Remember that the value of your premises or office should be based on the cost to rebuild it rather than its market price and should factor in professional fees, for example, surveyors, engineers, or architects. This is particularly important if your premises is a listed property or needs specialist materials or labour. Another cost you’ll need to remember to factor in is the cost of clearing any debris.

Some policies are also index-linked which means they automatically take into account factors including labour costs and raw materials. With current inflation however these should not be relied on.

Business growth

As your business changes you may need to adjust your sums insured (or estimates), to reflect your turnover, stock, or assets. For example, if, due to continued business growth, you carry twice as much stock as you held previously, your sums insured should be changed to reflect this difference.

Underinsurance vs self-insurance

Underinsurance should not get mixed up with self-insurance. If a business owner chooses not to insure some of their business equipment, for example, this is not underinsurance, but an example of self-insurance. However, it is very important to declare any assets you decide not to insure as, otherwise, it may be construed that you have knowingly underinsured your assets. Such decisions should be discussed with your insurers to avoid any doubt in the event of a claim.

Underinsurance vs inadequate cover

Aside from underinsurance, consideration should be given to inadequate insurance.

Examples of this would be:

• If you choose to take only £1m liability cover for a policy (such as Public, Products or Cyber Liability insurance policy) and a suffered loss extends to over that amount.
• The indemnity under your business interruption insurance does not reflect the period of time it takes your business turnover to recover to the same level as the day before the loss.
• Marine cargo is not adequately covered during the goods transit.
• Property is not covered away from your premises.
• Insurance against errors or omissions is not covered.

How can businesses avoid being underinsured?

Getting the right levels of business insurance can seem like a daunting task, especially if you’re also juggling the day-to-day running of your business. That’s where a specialist insurance broker such as Alan Boswell Group can help.

With years of expertise behind us, we’re able to assess your business needs objectively and help you arrive at an accurate sums insured to cut the risk of underinsurance. As well as features including business interruption and cyber insurance, we can discuss additional liability covers, including professional indemnity, to further reduce any potential risks. What’s more, you can be confident that all our advice will be tailored to suit you and your business, ensuring you get the value and support you need for your peace of mind.