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Underinsurance – What does it mean and how can it affect you?

16 May, 2019
Underinsurance remains a major issue within commercial insurance, and can be major factor in delays in repair authority and reduced claims payments. It’s estimated that 75% of commercial businesses are underinsured, however, it is only when a claim arises that underinsurance can be highlighted. Following a major loss it is a very stressful time for all involved and the last thing anyone needs is to be told they are underinsured and the insurer will be reducing their payment!

There’s a common misconception that, as long as the cost of the claim is below the sum insured, the claim will be paid and that undamaged buildings are not calculated within the ‘value at risk’ - this is incorrect.
What is ‘value at risk?
This is the rebuilding cost of all the property including demolition, landfill tax and professional fees (such as architects and planning permission, if required) at the time of the loss or at the time of reinstatement. In fact, the rebuild value can often be far higher than the market value because the insurer has to pay for the cost of repairs in addition to any professional fees.
What is ‘sum insured’?
Underwriters calculate premiums based on the sum insured – it’s the limit payable under the policy, and the onus is on the policyholder to select the appropriate sum insured. The purpose of checking the sum insured is to determine whether an appropriate premium has been collected. If the sum insured is deemed inadequate, the insurer is entitled to apply the ‘General Average’ condition, which can be found in most commercial and domestic policies.
What is ‘General Average’?
In the event of the sum insured being inadequate it permits the insurer to reduce their claims payment proportionately by the amount of underinsurance, with the policyholder bearing a proportion of the loss.
An example of underinsurance
A policyholder has three buildings on site which are insured for a total sum insured of £300,000, and fire breaks out in one building causing significant damage. The claim is reported to the insurer who appoints a Loss Adjuster to oversee the claim. The Loss Adjuster’s role is to determine if:
  • The value at risk, being £300,000, is adequate to reinstate all three buildings
  • The loss is covered under the terms of the policy
  • The repair costs are fair and reasonable
    While on site, the loss adjuster will measure each building to calculate whether the sum insured is adequate and reports back to the insurer that the ‘value at risk’ should be £600,000 and the ‘general average’ condition should be applied. Upon obtaining estimates, the cheapest estimate for repairs is £100,000. In this instance, the insurer would be entitled to reduce their claims payment to £50,000 as the value at risk was only 50% insured with the policyholder bearing the remaining 50%.
  • Why it’s important to get it right
    As you can see for the above example, it’s imperative that the sums insured are set an adequate level to ensure underinsurance is not an issue in the event of a claim. If there are buildings which are no longer used for whatever reason and you do not want to insure them then this is your prerogative, however, you must inform you broker/insurer to ensure this is noted on the policy. Otherwise, these buildings will be calculated within the value at risk by the loss adjuster.

    The issue with many commercial and farming risks is the buildings have been in situ for many years, and have never undergone an insurance rebuild valuation. This is where the AF insurance provider Alan Boswell Group can help as we are able to offer guidance on your sums insured by offering a free buildings valuation. Depending on the location a site visit will be arranged and measurements taken of each building. A report will be issued and findings discussed with the policyholder. While we are not professional valuers, we do use the approved Royal Institute of Chartered Surveyors (RICS) rebuild sums insured. The purpose of the valuation is give you a basic indication of the cost to rebuilding the property at the present time.
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    If you have any queries or would like to find out more please get in touch. 01603 881881Honingham Thorpe, Colton, Norwich, Norfolk NR9 5BZ
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