Beyond the policy: the dangers of underinsurance
Underinsurance is a common issue facing many policyholders, not just in the UK or Islands, but worldwide, worsened by rising inflation and the steady increase in rebuilding costs. Without adequate coverage, individuals and businesses can be left vulnerable to financial hardship and long-term consequences.
This article examines the major challenges and impacts of underinsurance, providing guidance for homeowners and businesses on how to bridge the gap in their financial planning to secure sufficient coverage.
What is underinsurance?
Underinsurance occurs when a policyholder has insufficient cover to meet their needs. Areas typically include property and contents for private customers and for businesses, buildings, assets such as plant, equipment and stock, along with business interruption.
The underinsurance problem
In simple terms, in the event of a claim, the amount may exceed the maximum limit the insurer is able to pay out. Whilst insurance offers financial protection, underinsurance leaves policyholders vulnerable, exposing them to significant out-of-pocket costs that their policies do not cover.
One cause is the dramatic rise in property values and living costs over the past few years. Many policyholders mistakenly believe that the insured value of their property is static, without realising that construction costs and materials rise over time. If policies are not updated regularly to reflect the current value, the insured value of a property, particularly for homeowners, may be insufficient to cover the rebuild or replacement.
Economic conditions can also play a part. Amidst the cost of living crisis, some individuals and businesses may not index link their policies in order to keep premiums down, or opt for cheaper cover with lower premiums. Such measures often come at the expense of coverage, as more affordable policies tend to provide less protection. This not only heightens the risk of financial loss but can also completely void coverage.
Insurance policies can also be complicated, with terminology and fine print that some people may find difficult to understand. Customers could unwittingly purchase policies that do not fully meet their needs and assume they are fully covered. The reality is that specific limits or exclusions leave them exposed, so adequate guidance from a broker or insurer is therefore essential in helping avoid these gaps.
What is the ‘average clause’?
This is a section of an insurance policy stating that the policyholder must bear a proportion of any loss if assets were insured for less than their full replacement value.
An insurer may reduce the pay out by the same proportion that the asset is underinsured. So, if underinsurance is 30%, the insurer may only pay 70% of the claim.
Having the right level of insurance is therefore key to ensuring policyholders are not left out of pocket, or their business disrupted, if they need to claim.
Consequences of underinsurance
For businesses and private policyholders, one of the main consequences of having insufficient funds to replace, rebuild or refurbish, is financial hardship. When suffering a loss, the policyholder may find that the payout from is considerably less than what is required to cover the full costs. This could lead to significant debt and financial hardship.
Underinsured small companies may face business interruption – downtime for buildings, machinery and equipment – and a negative impact on operational capabilities of the organisation.
Added to this is the potential for lengthy and complicated negotiations with insurers, leading to delayed rebuilds and for businesses, depleted management resources. And the final consideration is legal action from lenders and leaseholders, which may occur if the policyholder has failed to maintain sufficient coverage. All of these consequences add to financial strain.
How to reduce the gap and the risks?
The most effective way is through regular reinstatement cost assessments. These should be conducted regularly and more frequently if there is a significant change made to the insured asset, particularly any structural changes to a building.
Policyholders also need to ensure that the replacement cover is for the value of a new item, not for how much the contents are currently worth.
Improving communication between insurers and policyholders is also crucial. Insurers and brokers should play a more proactive role in educating their clients of the importance of these reviews and offer guidance on how to update coverage. This means simplifying communication, avoiding jargon and providing clear, easy-to-understand policy explanations.
The cost of being underinsured far outweighs the short-term savings on premiums, making it vital for all policyholders to ensure their insurance truly protects them when they need it most.
Services offered
Insurers are generally well versed in supporting policyholders.
Gallagher, one of the largest insurance broking groups in the world, provides a wide range of products, comprising appraisals, valuations and a risk management service.
Our policies are written on a new-for-old basis. We also offer business interruption cover for companies.
Gallagher’s team of specialists can help new customers and existing policyholders review their policy and contents to understand what level of cover they may require, so we would suggest contacting us at the first opportunity.
Contact details
Natasha Lucock, ACII Chartered Insurance Broker - Group Sales Development Director
Direct: +44 (0)1534 500639
Stephen Rafferty - Business Development Executive Channel Islands & Isle of Man
Direct: +44 (0)1534 500 516 | M: +44 (0)7797 845 038