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What should businesses be doing to mitigate the impact and make sure they continue to get the cover they need?

A perfect storm of factors, including the war in Ukraine and the global energy crisis, have caused a major spike in inflation that looks set to last well beyond 2022. Underinsurance is taking center stage right now.


November 2022

As your insurance broker, it’s our job to make sure we assess the risks you face and present an insurance portfolio that offers the correct level of protection you need if something goes wrong, and you need to make a claim. That portfolio could be made up of a variety of different types of cover across a number of insurance policies. Regardless of the type of cover, it is critical that the amount of your insurance is adequate and is up to date. If you have a claim and don’t have enough insurance, it could reduce the amount of money your insurer pays, or in the most severe circumstances, your insurer could look to avoid the policy altogether and cancel it from inception. 
It would come as a shock to most of us to find out that we are underinsured, so it’s useful to put this into context given the wider economic narrative of higher inflation, the cost-of-living crisis, and the wider global events affecting supply chains worldwide, which explains why unchecked you could find yourself underinsured.
In this article, we look at :
- What is underinsurance? 
- How much does changing my sums insured cost?
- Why do insurance brokers talk about underinsurance all the time?
- What is average and how will it affect an insurance claim?
- How can I avoid underinsurance?
- Underinsurance within the wider context of the current economic and geopolitical landscape

What is underinsurance?

Underinsurance is when you don’t have enough insurance cover to cover a loss. If you are underinsured you could be faced with unexpected costs in the event of a claim, as you are effectively taking on a percentage of the risk. This could affect your ability to recover from a loss, you’d have to find the funds yourself to cover the shortfall.
Unfortunately, underinsurance usually becomes known when a claim has been made, at which point your insurer may look to correct the cover, asking for more premium to reflect the price if the sum insured had been correct however it is much more likely that they would reduce the claim payment, which is called the condition on average. 

How much does changing my sums insured cost? 

Understandably, you might be reading this and thinking "this sounds expensive" and while insurers would probably want more premium when you buy more insurance cover it might not be as much as you think, here’s why.
  •  It's always worth getting revised quotes so you can see the cost impact and make an informed decision. 
  •  The way premiums are calculated means that sometimes double the cover is not always double the premium.
  •  It will certainly be less than the amount you’d have to pay if you were underinsured, you’d effectively be self-insuring part of the risk but to do this intentionally would be potentially catastrophic if you have a claim.
We know there are pressures on costs and people are looking to make savings, if this is a concern for you, please get in touch with us as soon as possible. 

Why do insurance brokers talk about underinsurance all the time?

The Chartered Institute of Loss Adjusters estimates underinsurance to be present on over 40% of claims and the degree of underinsurance is typically around 35 to 45%. [1]
The situation is far from ideal but reflects the scale of the problem, which could affect your ability to recover after a claim. 
Underinsurance was a concern to the insurance industry long before the pandemic, but the recent economic downturn and global events have highlighted the risks of not having the right insurance. Brokers like us are working with our commercial insurance clients to make sure they have all the information they need to make an informed decision about the types and amount of insurance they require to protect them, as well as the consequences of not buying cover.

What is the condition of average and how will it affect a claim? 

Most commercial insurance policies are subject to an “average” clause.

Here’s how it works.

If you insure your property for £500,000 but the actual cost to rebuild it is £1,000,000 there is a £500,000 shortfall, you’ve only insured 50% of the rebuild cost of the property, so if there is a total loss you could be out of pocket to the tune of £750,000, because the insurer will only pay 50% of £500,000 sum insured. 

In the same way any partial loss will be reduced in the same proportion of the cost to rebuild, for example, if you have a loss of £50,000 and a £250 excess, the insurer will adjust the claim by 50% to £25,000 less the excess, paying £24,750 in total; this is called Average. It is worth noting that insurers deduct the excess after the adjustment for average is made.

It is rare, but some policies do not include the condition of average, but if there is a total loss the policy will only pay up to the sum insured and if that amount is wrong, the insurance policy won’t make up the shortfall. 

This example highlights the risk and financial impact of not buying enough insurance, but there are other dangers, with the introduction of the Insurance Act 2015 policyholders are duty-bound to disclose a material fact about the risk that they know or should know. If an insurer thinks that the policyholder's underinsurance was reckless or deliberate, they may void the policy (cancelling it as if it never existed), making no payment and leaving you uninsured for the full amount of the loss.

How can I avoid underinsurance?

Most people would be shocked to find out that they are underinsured, and underinsurance can arise for several reasons, but here are some tips to help you reduce the risk of underinsurance.
Understand reinstatement and replacement costs
The purpose of your insurance is to put you back in the same position as you were in immediately before the loss and as such there are three ways a policy can work; 
  1. Indemnity basis. The settlement considers the age and condition of the property at the time of the loss and puts you back in the same position.
  2. Reinstatement basis. The settlement provides a replacement that is similar but not better than, also known as “new for old”.
  3. Agreed value basis. The settlement is based on an agreed amount at the start of the policy, this tends to be for the more unusual or historical property.
It is worth noting that the sums insured for buildings should be based on the cost of rebuilding, not the market value, and particular features of your premises might affect the cost of reconstruction. 
“An Allianz survey showed that 29% of those who own a business property used the market value to calculate the cost of rebuilding. “[2]
This can be dangerous because the market value could be higher or lower than the cost of rebuilding your property, it is also worth bearing in mind that the cost of rebuilding your property also includes driveway, garages, paths, fences, walls, and outbuildings* and the rebuild cost includes costs such as materials, labour, architects, legal fees, surveyors, demolition and debris removal, VAT, planning costs and inflation, which we will cover later in this article. 
*Check your policy as each will specify what is included in the definitions section of the policy wording.

Get a valuation

It is a common misconception that insurance brokers can advise on the correct sums insured but we are just not qualified to do this, so we would always recommend using a professional valuation service to help decide your sums insured, carried out by an RICS (Royal Institution of Chartered Surveyors) approved surveyor. Clarke Dove works with Rebuild Cost Assessment, who can provide you with an up-to-date valuation.
Use a Professional Insurance Broker 
A professional Insurance Broker like Clarke Dove can help you understand the scope and level of insurance cover you need to protect your business. We can help you navigate the different types of insurance available, the sums insured and indemnity periods to build you a comprehensive insurance portfolio. 
Underinsurance within the wider context of the current economic and geopolitical landscape
Insurance and Inflation
The UK inflation rate hit 9.9% in September 2022 and is predicted to reach 18% in 2023. [3] This will have a wider impact on the cost of raw materials, pushing up the costs of rebuilding properties, we are already seeing index linking (the amount by which insurers automatically increase sums insured each year) at as much as 17%. Inflationary pressures on raw materials costs, difficulty obtaining spare parts, and supply chain issues could also lead to insurance premium increases. 


Insurance and a recession

In a survey, 78% of SMEs said they see the cost-of-living crisis as their greatest threat [4] and this could have wider implications for their insurance protection, where there is pressure to cut costs or monitor spending there might be a temptation to reduce or cancel insurance cover that could mean businesses forgo vital insurance cover, or deliberately underestimate sums insured: A potentially dangerous strategy when coupled with higher inflation, as many types of businesses, should be considering increasing their sums insured not decreasing them. 
Insurance, war, and global economics
The impact of the war in Ukraine, China’s zero-Covid policy, and a global materials shortage might feel far from home, they all have an impact on the cost of insurance and how quickly insurers can respond to claims, as highlighted in Allianz Economic Insights (July 2022) [5].
The war in Ukraine continues to increase pressure on both energy and commodities, affected by supply chains across Europe it has led to higher prices for construction materials and scarcity has pushed up prices. China’s zero-Covid policy is set to continue, which has restricted manufacturing and logistics operations, leading to chip shortages. Exposing the fragility of our dependence on imports from China and the rest of the world and putting added pressure on the price of goods and affecting inflation. The summer's heatwave in Europe [6] also led to worries that low river levels in the Rhine would stifle the supply of key chemicals to the UK, a concern if your production methods rely on chemicals and pushing up costs if chemicals must be moved by land or rail instead. 
There is no denying that the UK’s ability to manufacture and supply goods is heavily reliant on our ability to import key components, and the cost and lead times of these goods affect the claims process in terms of how quickly a business can replace these goods if a claim occurs. If these costs are not covered because you are underinsured, it could be exceedingly difficult if not impossible for your business to recover from a claim.

What should I do if I think I am underinsured?

If you think you might be underinsured or have any questions about this article, please pick up the phone and give one of the team a call at 0115 962 0855, option 1, Our experienced team will be able to talk to you about your current insurance portfolio and any areas you think need reviewing in detail and make any necessary changes. If you do think you might be underinsured don’t wait until renewal, get in touch with us today.
Sources & Further Reading: 
[1] & [2] biba-how-to-avoid-underinsurance-1305.pdf 
[5] allianz-economic-insights-july-22.pdf