Underinsurance: Your Complete Guide

For many property owners, they won't realise they are underinsured until it's too late, and at a costly price. Underinsurance is surprisingly common - in fact, recent survey data suggests that 70% of residential properties and 79% of commercial properties are underinsured and not fully covered*. But the real concern lies in just how underinsured these properties often are; our survey data suggests that the average level of underinsurance for property insurance is 65%. This stark figure highlights the potential financial hardship many property owners could face in the event of a claim. 

This guide will help you understand what underinsurance is, how to find out if you're affected, and the steps you can take to avoid it, ensuring your wallet is protected.

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What is underinsurance?

Underinsurance is when your insurance policy does not provide enough cover to fully compensate for a loss. This means that in the event of a claim, the payout may be less than the actual cost of repairing or replacing the insured item, leaving you to pay the rest yourself. And in some severe cases of underinsurance, insurers may outright refuse to pay the claim altogether.

What is the 'average' clause?

Another important factor to consider is the 'average' clause, or 'average' rule. This is a mechanism that most insurance companies use to adjust claim payouts when a property is underinsured. If you haven't insured your property for its full value, the insurer hasn't collected enough premium to cover the real risk. 

In simple terms, the amount you receive in a claim is reduced proportionally to the degree you are underinsured. So, if you are 50% underinsured, your claim settlement will be reduced by 50%. 

How do insurers deal with underinsurance in the event of a claim?

In the event of a claim, insurers invariably adjust the amount paid out proportionately to the level of underinsurance. Let's look at an example of where this can be applied to a proportion of the sum insured for a personal property claim:

• Imagine you estimate the total value all the contents of your home to be £30,000, and you take out contents insurance for this amount.
• In the event that you need to make a claim, for example after a fire or burglary, and an evaluation reveals the total value of your contents to be £50,000, your policy only covers 60% of the value.
• With the average clause applied, your insurer may only pay 60% of your claim, as you were 40% underinsured. So, if you claim £10,000 in damages, instead of getting the full amount, the insurer may only pay £6,000, leaving you to cover the rest yourself.

Note: the average clause tends to apply to personal insurance, and is typically proportionate to the sum insured. For commercial insurance, insurers tend use a slightly different mechanism known as proportional settlement, whereby calculation is usually linked to the proportion of the premium the insurer received, compared to what the total premium should have been if the asset were fully insured.

However, the outcomes of using the average clause or proportional settlement to calculate claim payouts tend to be similar.

 

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How to identify and avoid underinsurance

• Understand policy limits and clauses: Familiarise yourself with all policy limits, exclusions, and especially the 'average' clause, as this can significantly reduce your payout if you are underinsured.
• Regularly review your insurance policy: If your insurance policy hasn't been reviewed or updated for several years, it likely doesn't reflect the current value of your building or contents.
• Compare the total value of your building and contents against the sum insured on your current insurance policy - if there is a big difference, you may be underinsured.

Below, we have created a step-by-step guide on how to accurately value your property for contents and buildings insurance and avoid underinsurance:

Understanding sums insured

Determining the correct sums insured is one of the most important things to consider when insuring property. Sums insured determine the compensation policyholders receive when making a claim and serve as the foundation for calculating premiums.

When determining the stock sum insured, the amount should reflect the highest possible value at any given time. This requires policyholders to take various factors into account, which will differ based on individual circumstances, to establish the appropriate amount.

How to value your belongings for contents insurance

1. Take inventory

If you're taking out contents insurance, you should include everything that you would take in a house move. Remember, although individual smaller items might seem insignificant, their cumulative value can significantly impact the total sum insured for contents - so you need to be thorough!

An easy way to take inventory efficiently is doing it room by room, and taking note of every item you would want replaced in the event of damage or loss. This could include:

• Furniture
• TVs
• Kitchenware
• Items of clothing
• Sport equipment
• Electronic devices (such as phones, laptops, and cameras)
• Curtains
• Bedding

Tip: you can use a home inventory app to easily keep track of all your items.

2. Calculate the replacement value of each item

Once you've taken inventory of all your contents, you now need to calculate their replacement value - the total value of all your items is the sum insured.

If you no longer have receipts or can't remember the purchase price of an item, you can easily check its value online.

Even if you can't find the exact item, looking at prices for similar items can provide a useful estimate. This is useful for items that have increased in value since you originally bought them.

Keep in mind that most insurers will have a 'single item limit' (a maximum amount they will pay for a single item of your belongings), which might be lower than the value of any one item in your home.

So, you should always check with your insurer to ensure adequate coverage before completing your inventory.

Note: High value items, such as art, expensive jewellery or heirlooms, may need a professional valuation.

Also, pay particular attention to any gold valuables - they often pose a significant risk for underinsurance due to their fluctuating market value, so will need regular revaluation.

 

 

3. Revalue your items regularly

When your policy is up for renewal, you should revalue any items that may have increased in value. This could include jewellery, art, or antiques.

How to value your home for buildings insurance

Just like for your contents, providing an accurate value and rebuild cost for your home is critical to avoid underinsurance; incorrectly calculating the total cost to rebuild your home after a loss could lead to insufficient insurance cover, forcing you to pay a substantial amount out of pocket to make up the shortfall.

1. Ensure you cover everything in the rebuild cost

Remember, the buildings sum insured is not the market value of your house. It should represent the total cost to rebuild your property entirely after a total loss (such as a fire).

This reinstatement value must cover everything necessary to rebuild your property, including:

• Demolition
• Site clearance
• Planning
• Materials
• Labour
• Any professional fees

2. Make sure you include everything defined as the 'building'

A 'building' is not just the main structure; it also includes additional features, such as:

• Foundations
• Internal fittings and fixtures
• Boundary walls
• Drains
• Landscaping
• Car parks
• Outbuildings

Not including such additional features in the valuation is a common cause of underinsurance. Remember to check your policy wording carefully to see what is included.

3. Calculate the rebuild cost

The best way to do this is using a surveyor. A qualified chartered surveyor has the expertise to identify and quantify all necessary factors for an accurate valuation, when calculating the sums insured for insurance purposes. If your property is an historic or listed building, it's recommended to use a chartered surveyor.

Nowadays, getting a property survey is easier and more affordable than ever. Many surveying firms allow you to get quotes and book surveys entirely online, at an reasonable price. 

Alternatively, you could use an online calculator to calculate the rebuild cost. The Building Cost Information Service (BCIS) has a useful rebuilding cost calculator you can find here. However, it's important to note that online calculators do not always provide an accurate valuation of your property; they are more of an estimation, so using a chartered surveyor is always the best option.

4. Keep track of improvements and modifications:

Any changes you make to the building, such as new extensions, kitchens, or bathrooms, can increase the rebuild cost.

It's crucial to tell your insurer and update your policy after such modifications to ensure your coverage remains adequate.

5. Account for inflation

Inflation can cause building materials and labour costs to rise over time. Make sure your policy includes index linking (which adjusts the sum insured), or make sure to review and adjust your coverage limits annually to factor in these rising costs.

 

 

Underinsurance in businesses

Underinsurance is a highly prevalent problem for businesses too, posing a significant threat for businesses of all sizes. If a business is found to be underinsured at the time of a claim, the consequences can be severe. But what are some of the ways businesses might be underinsured?

Common ways businesses may be underinsured

Incorrect sums insured

Similar to residential properties, an inaccurate calculation of the sums insured (i.e. the cost to reinstate a business in the event of a loss) could lead to businesses being underinsured. This includes the commercial property (encompassing all structures of the 'building') of a business and its contents.

Business interruption

This is a critical area often overlooked. Business interruption insurance covers lost income and additional expenses (like temporary relocation costs) if your business cannot operate due to an insured event. Underinsurance here typically stems from:

• Underestimating indemnity periods: businesses often underestimate the time it would realistically take to recover and return to normal trading levels after a major incident.
• Incorrect gross profit calculation: The definition of 'gross profit' for insurance purposes can differ from accounting definitions, potentially leading to insufficient coverage for lost revenue.

Professional indemnity

For service-based businesses, underinsurance can occur if the coverage limit isn't high enough to cover the potential financial impact of a professional error or omission.

Are you looking for professional indemnity insurance to protect your business? At Howden, our team of trusted experts can help you find a policy that’s the perfect fit for your business needs.

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How businesses can avoid underinsurance

Fortunately, there are ways to protect your business from underinsurance. Below are some of the ways to avoid underinsurance:

• Conduct regular valuations: Obtain professional valuations for buildings, equipment, and stock to ensure the sums insured reflects current replacement costs.
• Review and update policies annually: Use your policy renewal as an opportunity to review all aspects of your coverage and update for any changes in assets, operations, or market values.
• Communicate with your insurer: Inform your insurance company about any significant changes to your business, such as new contracts, expansions, major purchases, or changes in stock levels. They can provide expert advice and help tailor your cover to your the needs of your business.
• Be realistic about recovery times: When setting business interruption indemnity periods, be realistic about how long it would truly take to get your business back on its feet.

Underinsurance: key takeaways

• Underinsurance is when an insurance policy does not provide enough coverage to fully compensate for a loss, leaving policyholders responsible for the shortfall.
• For property owners, underinsurance can occur when the insurance policy does not provide enough cover to meet the full rebuild cost or replace the total value of your belongings, leaving you potentially facing significant out-of-pocket expenses in the event of a claim.
• The average clause in insurance policies can reduce your claim payment proportionally to how much you are underinsured, making it crucial to ensure you have enough cover.
• Accurate sums insured are crucial for both residential and commercial properties to ensure full protection.
• Accurately calculating the right amount of insurance involves understanding the full value of your building - including materials, labour, and professional fees - and the total value of your contents, including high value items that may need professional valuation.
• Practical tips to avoid underinsurance include taking a thorough inventory of your belongings, using rebuild cost calculators or chartered surveyors for accurate valuations, and informing your insurer about any changes to your property or possessions.
• Information provided to insurers should be accurate and up to date to avoid being left underinsured, which can lead to financial strain and complications when making a claim.
• Businesses can face underinsurance risks due to incorrect sums insured, underestimated business interruption coverage, and inadequate professional indemnity insurance.
• Steps to mitigate the risk of business underinsurance include regular valuations, reviewing and updating annual policies, communicating key business changes to insurers and setting realistic recovery timeframes for business interruption.

*Source:

• RebuildCostAssessment