Underinsurance can pose a threat to organisations of any size or sector. However, according to recent data, the most likely properties to be underinsured are sports and recreation centres.1 In this article, we explore underinsurance, how it occurs, its implications, and what you need to know to protect your organisation.
What is underinsurance?
Underinsurance occurs when a policyholder has inadequate insurance cover for their needs. In the event of a claim, this could mean a claim amount exceeding the maximum limit that can be settled by the insurance company. This could result in a shortfall for the policyholder and, potentially, financial loss. Common areas of underinsurance for organisations are property, stock and contents, plant and equipment, and business interruption.
How does a building or plant become underinsured?
There are several reasons a policyholder may be underinsured, including:
- Outdated, estimated or incorrectly calculated valuations.
- Inflation causes a mismatch between rising costs and static coverage limits.
- Insufficient limits in the insurance policy.
- Business interruption coverage and financial projections fall short of actual income loss.
- Delays with acquiring materials, the availability and cost of raw materials, contractors, and equipment, combined with extended planning procedures.
- Policyholder oversight or intentionally inaccurate sums insured declarations increase the risk of financial loss and potentially void insurance cover.
What problems can underinsurance cause?
Underinsurance poses several critical risks to businesses, including:
- Significant business interruption and a negative impact on your ability to function as an organisation.
- Prolonged unavailability of buildings, machinery or plant.
- Complex and extended negotiations with insurers, resulting in extended rebuild times and drained management resources.
- Lack of funds to complete the rebuild or the need to borrow on already stretched budgets.
- Exposure to potential legal action for inadequate levels of cover from lenders and leaseholders.
Did you know…
- 81% of properties in the UK, including those owned by charities, are underinsured2.
- 86% of charitable organisations are worried about the effect of the increased cost of living on them3, while nearly 65% are worried about the higher cost of stock, equipment and supplies4.
- 1 in 10 small and medium-sized organisations say they would not survive if they had to pay up to £10,000 towards a claim that was not fully covered by insurance5.
Which types of properties are most likely to be underinsured?
Whilst underinsurance can affect all types of properties for several reasons, recent research suggests that there are a number of property types most likely to be underinsured. The top five include6:
- Sports centres/recreation centres.
- Hospices.
- Public houses, licensed premises/hotels.
- Nursing homes/Care homes.
- Golf clubhouses.
What is ‘average clause’?
The Average Clause is a lesser-known condition of building insurance when a policyholder has under-valued the rebuild cost and made an insurance claim. The clause states that the policyholder must bear a proportion of any loss where assets were insured for less than their full replacement value. In this scenario, the insurer can reduce the settlement by the same percentage if the asset is underinsured.
The clause can be relevant to various types of property insurance, which may encompass coverage for buildings, contents, plants, machinery and business interruption. The specific terms and conditions outlined in your insurance policy will determine the applicability of the Average Clause.
For example, if your property insurance coverage falls short of the total reinstatement cost and you need to file a claim, the payout may not fully meet your needs, regardless of the claim’s size. This is because the percentage you are underinsured by can be deducted from your payout under the Average Clause in the policy.
Example Scenario
A Leisure Centre has a current sum insured of £7.2 million. A disaster strikes and flood damages most of the premises, but not all of it, and loss adjusters determine that the actual rebuilding cost is £9 million, indicating a 20% underinsurance.
The loss is calculated at £5 million, but when the insurer applies the Average Clause, the claim payment is reduced by the amount of underinsurance (20%). As a result, the policyholder faces a shortfall of £1 million in covering the full repair costs. A Reinstatement Cost Assessment would have helped identify the underinsurance on which the policyholder could have acted.
What is reinstatement cost assessment (RCA)?
An RCA is a process used to determine the estimated cost of rebuilding or repairing a property to its original condition in the event of damage or destruction. It is typically conducted by a professional surveyor or valuer who evaluates various factors such as the size, construction type, materials used and specific features of the property. The assessment considers the current market prices of labour, materials, and other associated costs to provide an accurate estimate of the reinstatement cost. This assessment helps insurance companies determine the appropriate coverage limits for property insurance policies to ensure that policyholders are adequately protected in the event of a loss.
How can Gallagher help?
Our team can help to safeguard your organisation against unforeseen losses by reviewing your insurance to find any cover gaps and creating a policy that reflects your needs. We can also provide you with a quote for a rebuild valuation from a RICS (Royal Institute of Chartered Surveyors) qualified surveyor, ensuring your property is accurately assessed for insurance purposes.
If you would like to discuss your insurance programme or book a property valuation, please get in touch with Gallagher's Charities SME & Mid-Market team or call us on 0121 407 4101. We are here to support you.