General news
What is Underinsurance?
Wed, March 26, 2025
Underinsurance occurs when an insurance policy doesn’t provide enough cover to fully protect against potential losses. This can affect both the buildings, contents and business interruption sections of an insurance portfolio.
It’s estimated that up to half of commercial properties and two-thirds of business interruption claims are underinsured. This issue remains significant for many businesses. When assets are undervalued, or not declared at their full replacement value, businesses risk not being paid in full in the event of a loss.
Why Underinsurance Happens
Economic challenges, higher inflation, supply chain problems, increased building costs, and higher new asset replacement costs can lead to underinsurance. And when assets aren’t regularly or thoroughly valued, underinsurance is likely to occur.
A common example is insuring buildings for their market value instead of their rebuilding cost. Another example in respect of machinery is insuring it for original cost price as opposed to its current replacement cost as new, especially if the machinery is older.
Business Interruption
The basis of cover for business interruption is usually gross profit and it is important that this is carefully evaluated and correctly defined, considering current company financials and future projections.
Equally important is the indemnity period, which is the amount of time insurers would continue to pay to get your business back up to full operational effectiveness – and this can often be underestimated. Outside factors such as the availability of alterative suitable premises, planning permission, logistics challenges and supply chain delays can all conspire to make this period longer than expected.
Consequences of Underinsurance
Underinsurance can have serious financial consequences. Insurers are likely to apply the average condition, which is included in most policy wordings. Here’s an example related to buildings insurance:
- Imagine you own a commercial building valued at £500,000, but you only insure it for £300,000.
- This means you are underinsured by 40%.
- If a fire causes £200,000 in damage, your insurance company will apply a proportionate settlement.
- They will cover only 60% of the repair costs (since £300,000 is 60% of £500,000).
- So, instead of receiving the full £200,000 for repairs, you would only get £120,000 (60% of £200,000). The remaining £80,000 would be your responsibility.
This example highlights the importance of ensuring your assets are adequately insured to avoid significant uninsured losses in the event of a claim.
For any assets, it is recommended that you obtain a professional and regular reinstatement cost assessment to ensure your sums insured are adequate.
For more information or to discuss how we can assist in ensuring your business is adequately protected, please get in touch.