Spotlight: Why buildings underinsurance is bad for business

Based on current statistics, the insurance industry has some way to go in tackling buildings underinsurance. But for brokers that make a concerted effort to address this issue, client loyalty is a potential reward that cannot be ignored, as Tim Evershed discovers

Although the past few years have seen an improvement in the UK’s rates of buildings underinsurance, the overall levels remain stubbornly high. The average gap between the sums insured and what is actually required leaves significant values uninsured on policies.

Underinsurance occurs when the insured has taken out insufficient insurance cover, leaving it responsible for a percentage of a loss or expense. This can lead to extended business closures, insufficient funds for rebuilds and financial hardship.

‘Unacceptably high’ underinsurance

The percentage of UK buildings that are underinsured has fallen to its lowest level for at least six years, according to latest research from property valuation experts RebuildCostASSESSMENT.com.

The research showed that 76% of UK buildings are underinsured. This percentage has fallen from 81% in 2023 and from an all-time-high of 83% recorded in 2022 but remains “unacceptably high”, according to the insurance valuations provider.

In addition, properties found to be underinsured are on average still only covered for 63% of the amount they should be.

It can get very complicated but, effectively, if you’ve only got 50% insurance cover, you’re only going to get 50% back if you claim.

Paul Lawrence, Thompson & Bryan

“Underinsurance occurs when the cover provided under an insurance policy is insufficient to cover the risk being insured,” says Phil Daly, claims director at Gallagher UK.

“Underinsurance poses a substantial risk to businesses and individuals, as they could end up having to foot some or all of the financial costs if a claim is only partly paid or rejected. For businesses, underinsurance could lead to an extended period of business interruption (BI) which also carries a financial risk.

“Market value is the price an asset would fetch in the marketplace whereas rebuild cost is the amount it would cost to rebuild an item ‘from the ground up’ and is affected by things such as the cost of labour and materials which could be higher or lower than the market value,” Daly says.

Serious consequences

Where an insurer has agreed to insure a property, that property should be covered for the full reinstatement value of putting that building back into a condition as good, if not better, than it was before.

Paul Lawrence, managing director at loss adjusters Thompson & Bryan, says, “It can get very complicated but, effectively, if you’ve only got 50% insurance cover, you’re only going to get 50% back if you claim. That’s all you’re going to get back.

If you underinsure deliberately there has to be some sort of sanction otherwise everybody would do it.

Douglas Brown, Renovation Underwriting

“There are situations where the owner takes a loss and everything is destroyed and you prove you’ve got more than the sum insured and there’s no residual value, you’ve got nothing left, you will get the sum insured. That’s where things differ somewhat.”

In essence this means the insured is only going to get the proportion for which they insured the property. If they insured a building for £100,000 and it costs £200,000 to reinstate, they will only get 50% of their claim back. So, it is important to insure the full reinstatement value at the time of the loss.

This can have an impact on the insurer as well as insured.

Douglas Brown, managing director at Renovation Underwriting, says, “If you’re somebody who is underinsured and misrepresenting your risk, it means the premium the insurance company is collecting isn’t the correct insurance. So, that premium is not right for the size and complexity of the risk.

“There is an onus on everybody to disclose the right sums insured and if you underinsure deliberately there has to be some sort of sanction otherwise everybody would do it. The ‘condition of average’ is a sanction but in a perfect world we wouldn’t get to that position to start with.”

Causes of underinsurance

There are many causes of underinsurance, from an absence of advice from a broker to a lack of awareness of the problem. Those insureds that go direct to insurers may not be able to get the correct advice or ask the right questions so end up with inadequate cover. They can also misinterpret the insurance cover.

Brokers have a real opportunity to demonstrate their value as their understanding of insurance products, including valuations and the claims process, means they can guide insureds in getting the coverage that best suits their needs.

Many businesses do not appreciate that the sum insured for buildings is based on the rebuild value, not the market value.

Understanding business interruption

For business interruption policies it is vital to understand that a definition of ‘gross profit’ in an insurance policy is usually different to an accountant’s definition.

This can cause an inaccurate BI sum insured. Similarly, it is easy for businesses to underestimate the time that it could take to regain the trading position they were in before the loss. 

The British Insurance Brokers’ Association (BIBA) now recommends that a minimum indemnity period under a BI policy should be two years.

And it is important to remember that values change, particularly when inflation is high, as it was in the aftermath of the Covid-19 pandemic and Russia’s invasion of Ukraine.

Lawrence says, “The interpretation of policy is key, having a good broker to give advice, having a broker that does the due diligence on your business is key. Not everybody has an insurance broker, some people go direct today.

“They might be taking their chances, going on price rather than the policy itself.”

Underwriter insistence

It is also vital that underwriters insist that the sum insured is right from day one, which makes the claims process easier and ensures settlements are accurate.

Brown says, “Other insurers, particularly direct insurers, will accept the sum insured and then underwrite at point of claim, which is a slightly disingenuous thing to do. Having said that, if someone does not care enough about their [property] to underinsure it, then it cuts both ways.

If people were as careful about the wording they bought as they are about the premium they paid, then they would get themselves in a whole lot less trouble.

Douglas Brown, Renovation Underwriting

“The regulation is sometimes slightly unhelpful in that it’s more about compliance than the core function that insurance is.

“Nobody complains about paying five percent more premium than they thought they should when they are having a major claim paid and there’s no problem. That’s really the way you have to look at it.

“The advent of price comparison sites has brought us to a position where people know the cost of everything but the value of nothing. You have to combine that with the way people are blasé about the policy wording.

“Price comparison sites produce very stiff competition between insurers as far as the premium is concerned but do they produce stiff competition as far as wordings are concerned? If people were as careful about the wording they bought as they are about the premium they paid, then they would get themselves in a whole lot less trouble.”

Overinsurance

At the other end of the scale to underinsurance is the far less common issue of overinsurance. While not as much of an issue as underinsurance it can still be a problem.

Overinsurance is when the sums insured are more than the cost to rebuild. This is somewhat futile as insurers are only obliged to pay for the rebuild of the property so there is no point in overinsuring. It also means that the policyholder is paying more than necessary for their policy.

Daly says: “Overinsurance is where the insurance coverage is higher than is actually required, where the true cost of the item or risk being insured is not correctly estimated.

“There are downsides such as paying more for your insurance every year than you need to. Paying a higher premium and reaping no additional benefits is not cost-effective, however brokers can play a key role in helping businesses and individuals avoid this by accurately assessing their needs and risks.”

Whether it is underinsurance or overinsurance, it is clear the industry still has a long way to go in understanding how to tackle it. But for those that show their value, client loyalty is the potential reward.

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