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Underinsurance: How declaring less could cost you more

Have you ever heard of ‘Underinsurance’?
When it comes to insurance cover, accurately assessing the value of your assets can make all the difference. 

In this blog post, we’ll delve into the importance of accurately declaring asset values, the factors that contribute to Underinsurance, and steps you can take to ensure your cover aligns with the true value of your assets.

So let’s dive in and explore how to help safeguard your financial well-being through proactive insurance management.

What is Underinsurance?

It’s a concept that may have significant financial implications if not properly understood.

‘Underinsurance’ is when building(s) or contents Sum Insured values fall short of their actual worth in the event of a claim. This means your insurance payout may not adequately cover the real costs of loss or damage – leaving you with unexpected expenses.

Home buildings and contents, fire, business interruption, industrial special risks and other policies often contain an average clause. This means that you should insure for full value which may be replacement, indemnity or market value depending on the type of insurance cover arranged. If you are under insured your claim may be reduced in proportion to the amount of under-insurance

So, if you have Property insurance cover, you might think you’re protected from any loss or damage described in the policy wording, but the reality is you may not be fully protected if you’ve underinsured and this can have serious consequences in the event of a loss.  

There are many reasons why underinsurance may occur:

Most commonly it’s when:

  • You underestimate the value of your assets;
  • You extend a building, make improvements or build a new one;
  • You don’t regulary review your sums insured. These values should keep pace with inflation as this impacts on rebuilding/replacement costs that increase over time. 

The case study of a management committee…

  • Imagine being part of the management committee of a community hall in the picturesque Victorian countryside. Your responsibility is to ensure the protection of this cherished community asset.
  • A decision has been made to purchase a property damage insurance policy for the hall Building without taking professional advice on its replacement value but believing that you have adequately safeguarded the asset with a Sum Insured of $300,000 for the Building itself.
  • Unbeknown to the committee, the true value/cost to rebuild the hall is a staggering $500,000.
  • This stark discrepancy of $200,000 reveals a distressing truth – In the event of a claim, you are underinsured.
  • The potential impact of this is enormous and we have set out two case studies to illustrate what could occur.

Some scenarios to illustrate what could occur if you are Underinsured:

Scenario 1:
  • The building suffers substantial fire damage, it is beyond repair, this is what the insurance industry calls a total loss. 
  • In the event of a total loss, the insurer will pay to the maximum Sum Insured value. 
  • This is $300,000 in this case  because it’s the value of cover purchased.
Scenario 2:
  • A wind storm rips through town: We’ve discussed Underinsurance in the event of a total loss, but what if only the roof blows off causing a partial loss to the building, with a cost of $180,000 to replace the roof?
  • If your Sum Insured is $300,000, but the true value/cost is $500,000 the answer is the building is Underinsured by 40%.
  • So is the roof part of the $300,000 you insured or part of the $200,000 you didn’t insure?
  • As you have only insured the building for 60% of the true value/cost, the insurer will only pay 60% of the cost of claim (60% of $180,000 = $108,000). The other 40% is your cost ($72,000). 
  • Again, the incorrect declared value in the Sum Insured has left you short of funds in the event of a claim.

Key take aways…

The story of the underinsured community hall serves as a cautionary tale for all.

In both scenarios, the valuation discrepancy leaves the management committee financially exposed in the event of either claim.

Recognising the importance of an accurate valuation, the committee realised that engaging a professional valuer for an insurance valuation was not just common sense, but prudent risk management. It became clear that without a comprehensive understanding of the hall’s value, they were at risk of Underinsurance.

How do I know what my Sum Insured should be?

The responsibility for ensuring an adequate Sum Insured cover lies with you, the policyholder.

You should source some professional/qualified advice but here are some general guidelines about Sums Insured, as insurance policies have a specific way of defining replacement value.

Let’s start with buildings:

The Sum Insured value should be replacement cost of your building(s) constructed in same/similar materials as already there. It does not matter that it can be done differently in alternative materials, the standardised measure is to replace the existing on a ‘new for old’ basis.

So the starting point for determining a Sum Insured is the cost to build the property today using same/similar materials. This probably means you need to engage a professional valuer or similarly qualified expert.

Considering other expenses related to rebuilding:

When determining your building Sum Insured, not only should you consider a ‘new for old’ replacement cost of the building, but also the other expenses related to rebuilding, such as:

  • Cost of demolition and removal of debris which would be required if the building was substantially damaged and has to be totally rebuilt. This cost should also include an allowance for removing foundations/footings.
  • Where there’s an older building then rebuilding after a major loss may see the application of updated local planning rules which will have an impact on the cost of any rebuild. For example, disability access and amenities like disabled toilets which may not be present in the current structure but will be required under revised building code(s).
  • There may be modern requirements around fire sprinklers, fire hoses, smoke/heat detectors, or other mandated safety fit-outs such as additional fire exits. Perhaps environmental improvements apply, this could include water recycling, water tanks, solar panels, or other passive energy design features.
  • What is the cost of architect fees for plan/design submission to local authority/building development assessment panel? It’s also likely the building, depending on age and/or size and/or use, will require engineering specifications which are separate costs to architect fees.
  • Do you have neighbours? If the site is in a residential area, noise and dust from repairs may have to be suppressed so neighbouring properties are not inconvenienced. This may also impact on the value to be insured as it will impact on rebuild costs.
  • Finally, if it’s a cost of (for example) $1,000,000 to rebuild now, what impact will inflation and increasing costs of building materials and labour have in the coming 12 months? After all, an insurance policy runs for a year so allowances should be made for these.

For the avoidance of doubt…

If there’s been no movement in the Sum Insured value(s) of a property for two years or more, then it’s likely to be Underinsured and you may not have adequate insurance cover to meet the costs in the event of a major loss.

 

Still reading? Good!

We trust you get why a regular review of Sum Insured for buildings is important. Our recommendation is to consider getting the right base/starting point and consider using a qualified expert/advisor such as a professional valuer or building company if you’re unable to correctly value the assets.

Don’t forget about your contents – they have a value!

  • When it comes to insurance, many people focus on insuring their buildings and other property, but it’s important to pay attention to the value of the contents. 
  • Your group’s belongings, furniture, and other possessions can add up to a significant amount and they’re all at risk of damage or loss.
  • Contents are also Insured for replacement value, and the Sum Insured must stay relevant to the cost of replacing items at a value of new for old items.
  • Therefore, we recommend you consider reviewing the values for these assets at the same time you review your buildings.

Don’t let inflation deflate your insurance cover:
Underinsurance can be problematic when inflation is factored in…

  • As the ‘cost of living’ is impacted by inflation, so is the cost of building.
  • Inflation increases prices/costs when building, rebuilding and buying new contents. 
  • That’s why it can get more expensive as time goes by – inflation is the general increase in the price of goods and services over time.
  • As inflation can significantly impact the cost of repairing or replacing damaged assets, it’s also important to regularly review the Sum Insured for these to cover the full cost in event of an insured loss.

Can LCIS value my assets?

Curious about how much your assets are worth? While we’d love to help you out, our staff aren’t certified valuers/appraisers. We’re just insurance experts. But don’t worry, we can point you in the right direction to find a qualified expert who can give you an accurate valuation.

Using a qualified valuer to assess your assets is a more reliable and accurate option than trying to estimate the value yourself. Valuers are trained professionals who have the knowledge and expertise to assess the value of assets accurately.

Valuers have access to the latest market data and use specialised techniques and methodologies to ensure their valuations are as accurate and reliable as possible. They have no vested interest in the value of your assets and can provide unbiased assessments unclouded by personal feelings, emotional ties or opinions.

Valuers also assess the value of the contents of a building. This can be especially important for organisations which have a significant amount of electronic equipment including computers, printers, furniture and fixtures (such as desks, chairs, and shelving) or high value items such as machinery, artwork, and collectibles.

Where to check your Sums Insured:

Unsure what your current Sums Insured values are? In the case of LCIS Business Pack policyholders - to check your current Sums Insured, take a look at the Business Pack Policy Schedule which is included as part of the Tax Invoice. This area of the document lists the Sums Insured for each of your assets.

It is important to carefully review all of the documentation to ensure the most relevant and up-to-date information has been provided and you understand what is covered.

If any changes are necessary, please contact us immediately. Remember, it’s your responsibility as the policyholder to inform LCIS of any changes to your organisation, such as new assets or changes in the value of existing assets. Failing to do so may impact your insurance cover.

Some final thoughts…

The bottom line is policyholders are responsible for checking they have an accurate Sum Insured.

To prevent Underinsurance, regular reviews and updates of Sums Insured are paramount. These updates should reflect the current value of your assets based on their replacement or reinstatement cost as per the insurance policy. If you find it challenging to estimate the value accurately, seeking the expertise of qualified valuers becomes essential. While the cost of a professional valuation may seem like an additional expense, it can be a wise investment in the long run.

By avoiding Underinsurance, you can help safeguard yourself against substantial out-of-pocket expenses and ensure adequate cover in the unfortunate event of a loss.

Got insurance questions? Our team is here to help

If you have any questions or need assistance regarding Sums Insured or any other insurance-related topic, don’t hesitate to reach out. Our team is here to help and can explain any points you may be unsure of. We want to make sure you have the right cover to protect you and your organisation in case of any unforeseen events.

Don’t have property cover?

No worries! Our Property & Asset Insurance (Business Pack) cover is designed to safeguard your group’s property and belongings against risks of loss or damage, including fire, theft, and accidental damage.

To get a quote and protect your valuable assets, download the application form, complete the relevant sections, and return it to us via:

Post: Local Community Insurance Services, GPO Box 1693 Adelaide SA 5001
Email: insurance@lcis.com.au

The above statements are issued as a matter of information only and for full terms and conditions you should refer to the Policy Wording.
LCPA# 24/516.

 




Local Community Insurance Services (LCIS) is a division of JLT Risk Solutions Pty Ltd (ABN 69 009 098 864 AFS Licence No: 226827) (“JLT”) and is a business of Marsh McLennan. This insurance is issued via this website by JLT Risk Solutions Pty Ltd (ABN 69 009 098 864 AFS Licence No: 226827) (“JLT”) under an authority to bind cover on behalf of the insurer. In issuing and underwriting this insurance, JLT acts as agent of the insurer and not as your agent. 

If JLT cannot issue insurance to you as an agent of an insurer because the underwriting information you have provided means that the insurable risk falls outside of our Binding Authority, JLT can instead arrange your insurance on the open market as your agent. In this instance, JLT will be acting in a dual capacity, as an agent for the insurer in collecting the information and then as your agent in arranging the insurance. JLT will also be acting in such a dual capacity in circumstances where you have obtained multiple insurance policies through JLT, where some of those policies have been issued by JLT as agent of an insurer and others have been arranged by JLT as your agent. All insurance coverage is subject to the terms, conditions and exclusions of the applicable individual policies. JLT cannot provide any assurance that insurance can be obtained for any particular client or for any particular risk.

This website contains general information, does not take into account your individual objectives, financial situation or needs and may not suit your personal circumstances. For full details of the terms, conditions and limitations of the covers and before making any decision about whether to acquire a product, refer to the specific policy wordings and/or Product Disclosure Statements available from LCIS on request.

JLT arrange insurance and premium costs directly to not-for-profit clubs and community groups. Quotations, renewals and new business policies are not to be accessed and resold by insurance advisers or other insurance intermediaries.