Underinsurance: Don’t Let Your Business Be Caught Out

Key Terms

• Underinsurance
• Sums insured
• Application of average
• New for old

What Is It?

Your insurance policy is designed to protect your business in the event of a loss. When you take out an insurance policy, your policy will include sums insured. These are the maximum amounts that your insurance company will pay out on a claim. You will have different sections in your policy, for each area that is insured. For most businesses these will include Stock, Contents and Business Interruption. Each of these sections will have its own sum insured, and each sum insured should be appropriate for your business.

The sum insured should be sufficient to cover a total loss. For example, your sum insured for stock should be enough to replace every item of stock you have. Your sum insured for contents should be enough to replace all machinery, furniture, electronics and all other contents. It is important to check each sum insured carefully, as your insurance policy could have sufficient coverage in one area, whilst being significantly underinsured in another.

Application of Average

If you are underinsured, your insurer will adjust your payout in proportion to your level of underinsurance. Often, this will be done through the application of average. Insurers calculate the adequacy, or sufficiency, of your coverage by calculating what percentage of the true value are covered by your sums insured. For example, if your stock is insured for £60,000, but the true value of your stock is £100,000, then you would be 60% adequately insured, and 40% underinsured. Any claimed amount for stock would then be reduced by 40%. If you are underinsured, average will be applied even if the claimed amount is less than your sum insured. For example, if you claimed for £40,000 at 60% adequacy, it would be reduced to £24,000.

New For Old

Many insurance policies operate on a new for old basis. This means that items that are lost, stolen or destroyed are replaced by new equivalents. Whilst this ensures the business receives a full replacement cost, it can often catch businesses out, as they undervalue their contents. An old machine may have a low value, but the cost of a new machine may be much higher. There are alternatives to new for old insurance, like a cash settlement, that may be better suited for your claim.

Policy Voidance

If information is misrepresented when a policy is taken out, then an insurer may refuse to pay out on a claim entirely and void the policy, especially if an insurer believes that a business had deliberately undervalued their required sums insured. This leaves the business with no cover, meaning they will be forced to cover all costs themselves.

Business Interruption

Business interruption cover is easy to misjudge, not least because it contains two different elements, both of which need to be suitable for your business for cover to be effective. Business Interruption includes a sum insured, just like stock or contents. However, it also includes an indemnity period. This is the maximum period for which your insurer will pay business interruption cover.

It is not always obvious how long it will take a business to recover after a loss, so it is best to err on the side of caution when selecting an indemnity period. Businesses that rely on specialist or bespoke machinery, parts or equipment are especially susceptible to interruptions, as they can find it challenging to source replacements. If your indemnity period runs out before your business has financially recovered, then you will no longer receive what could be vital payments from the insurer. The longer your indemnity period is, though, the higher your sum insured will need to be to cover this period.

How to Check

The best way to check if you are underinsured, is to check your insurance policy regularly, and to update if necessary. Don’t just renew your policy without considering if your sums insured need to be updated. You should consider:

• If your business has expanded, or your revenue has increased.
• If you have purchased new machinery or equipment.
• If the value of your machinery or equipment has changed.
• If you have renovated or improved your premises.
• If there are any policy exclusions that need to be amended.

If you have doubts or concerns when taking out or renewing your cover, you could consult an insurance broker to help you. Brokers have a duty to recommend sufficient cover and will help guide you through the process of adequately insuring your business. It is also possible to have your business professionally valued. These assessments cover all parts of your business and will provide an accurate valuation.