Underinsurance in property – it’s a risky business

This article originally appeared in the summer 2019 edition of Telegraph magazine. Read it online now.

The myth goes, as long as the cost of a claim is below the sum insured, the claim will be paid and any undamaged buildings ignored within the calculation. This is incorrect. It’s only in the event of a claim that underinsurance is uncovered. Some people may not have heard the term underinsurance, nor understand what it means. Following a loss, the last thing anyone wants to hear is that they’re underinsured and the insurer is reducing their payment!

How to find out your value at risk

It’s the rebuilding cost of the whole property at the time of the claim, including:

• Demolition
• Landfill tax
• Professional fees, such as architects and planning permission

It’s true that the rebuild value can often be far higher than the market value of the property, because the insurer has to pay for the cost of repairs in addition to any professional fees.

How it’s different to your sum insured

Underwriters calculate premiums based on the sum insured – it’s the limit payable under the policy. As the policyholder, it’s your responsibility to select the correct value. If you have to make a claim, the insurer will check the sum insured to determine whether an appropriate premium has been collected. If it’s deemed too low, the insurer is entitled to apply the ‘General Average’ condition, which can be found in most commercial and domestic policies.

When your sum insured is inadequate, the insurer can apply the rule of General Average to reduce their claims payment proportionately by the amount of underinsurance. If this happens to you you’ll have to bear a percentage of that loss.

According to a survey by valuer Barrett Corp & Harrington, more than 75% of properties they survey are underinsured. In 2018, they assessed £2.08bn worth of property. The result of their assessment was an additional 28% added to sums insured.

How it happens

It’s almost always accidental, but there are a few things to bear in mind to make sure it doesn’t happen to you:

• Inflation
• Accidental omission of items
• Cost in reinstatement, for example if the building is listed

Here’s a different example of underinsurance; a policyholder has three buildings on their land, and they’re insured for a total sum insured of £300,000. A fire breaks out in one of the buildings and causes significant damage. The claim is reported to the insurer who appoints a Loss Adjuster to oversee the claim and determine if:

• The value at risk (£300,000) is adequate to reinstate all three buildings
• The loss is covered under the terms of the policy
• The repair costs are fair and reasonable

While on site, the Loss Adjuster reviews each building to calculate whether the sum insured is adequate. They report back to the insurer that the value at risk should actually be £600,000. The insurer applies the general average condition. Upon obtaining estimates, the cheapest estimate for repairs is £100,000.

Because the value at risk was only 50% insured, the insurer would pay £50,000 and give the policyholder responsibility for the remaining 50%.

Why it’s important to get it right

As you can see from the above example, it’s essential the sums insured are set at an adequate level to ensure underinsurance is not an issue in the event of a claim.

If you have buildings which you no longer use and you don’t want to insure them, that’s OK. However, you must inform you broker/insurer to make sure it’s noted on the policy. Otherwise, they’ll be included within the value at risk by the Loss Adjuster.

Sometimes buildings have been in situ for many years, and have never undergone an insurance rebuild valuation. We can offer guidance on your sums insured and arrange a buildings valuation by a RICS accredited surveyor.