The unseen cost to business of underinsurance
If you add up all your business assets, how much is your business worth? Not how much it’s insured for, but how much it is actually worth to replace.
It’s one of the most important insurance questions, because when it comes to valuing assets, the temptation to undervalue often presents itself. As one prospective client explained it, he undervalues to “get the premium down”.
His thinking was based around the assumption that even if he was underinsured for a total loss, the policy would still fully pay out for partial damage as long as the claim remained within the overall sum insured total. But that’s not how it works.
What is Underinsurance?
Such a misunderstanding could have left his business more exposed than he’d intended. If a business is underinsured for the total loss, then any claim for partial damage will also be settled at a proportion of what the total sum insured is as compared to the actual replacement value.
Take the scenario of a commercial building that is insured for $500,000, when the correctly calculated replacement value would be $1,000,000. The business owner might think partial damage worth, say, $150,000 would be fully covered as it falls within the sum insured level.
But most commercial insurance policies have what’s called a “co-insurance clause”. A co-insurance clause is a provision in an insurance policy that requires the insured to bear a portion of the loss if the amount insured is less than a specified percentage of the actual replacement value of the insured item. It’s designed to encourage policyholders to insure their property to its full value. In the example above, only $75,000 would be paid to the business owner, as the 50% co-insurance rate, would also be applied to claims for partial loss or damage.
Why do Underinsurance clauses exist?
The approach helps insurers receive correctly priced premium payments for the level of risk they are taking on, whether that’s for total damage or losses at lower levels. It discourages people from gambling with underinsurance and realising too late that it is a false saving, and it also ensures those who accurately declare asset values are not subsidising those who don’t.
Majority of policies have an underinsurance clause and many policies allow a degree of tolerance for getting the total insured value correct, providing leeway for various fluctuations and small errors. The proportional impact for partial loss claims in those cases will kick in when the underinsurance margin falls below a certain level, which in some policies could be 85%.
The Dangers of Underinsurance
- Financial Risk: You could be out of pocket as a result of a gap in cover.
- False sense of security: You may find out too late that you have inadequate cover, which will lead to frustration and operational stress.
- Business recovery affected: Underinsurance may lead to inadequate funds to rebuild assets or recover lost income.
In recent years, the cost to rebuild and refit premises has increased substantially. If you haven’t reviewed and updated your sums insured within your current polices, you may be underinsured and exposing your business and its shareholders to unnecessary financial pressures in the event of an insurable loss. Having inadequate insurance cover can prove devastating for a business.
Premium levels in the commercial insurance market have softened in recent times and it is well worthwhile exploring alternative options and reviewing your sums insured. At Austbrokers Countrywide Insurance brokers we can provide a no obligation review and quote of your current arrangements. Its as easy as completing providing some simple details here.
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