‍Underinsurance and Inflation – what every business should know

When considering high inflation rates, the thought is often accompanied by ideas of extortionate energy prices, increased consumer goods costs, and perhaps even the Big Mac Index. 

What many companies don’t think about is their insurance. As inflation rises, so does the risk of underinsurance, particularly concerning property policies.

To tackle the issue of underinsurance, it’s critical to understand it at every level. At its most basic, insurance is a safety net to reduce the financial burden of fixing or repairing an issue. 

Underinsurance occurs when a company or person has insufficient insurance coverage that leaves them responsible for paying for a large percentage of the financial repair costs.

Not taking out comprehensive cover is risky as it leaves the policyholder susceptible to having to make a hefty pay out. Despite the risks, half of UK companies are underinsured. 

‍What is the link between inflation and insurance? 

The relationship between inflation and insurance exists because they share many of the same drivers. For example, when machinery and labour costs increase, repairs will cost the insurer more, meaning the policy will no longer be sufficient to cover the costs.

To counteract the effects of inflation and protect the company’s insurance policy, insurers recommend an index linking percentage, which, put simply, is an annual increase against the sums insured. However, given the extreme economic conditions that we’re experiencing, this may not be sufficient protection. 

Additionally, due to rising costs, businesses are choosing not to index link their policies to keep costs down, making underinsurance even more likely.

‍How does this affect property insurance?

Property insurance is intensely affected by the heightened inflation rate. Affected by supply chain disruption, material shortages, manufacturing delays, and construction-skilled labour shortages, construction work costs have increased dramatically. This means insurance policies may no longer be adequate to cover required repairs.

Underinsurance can also occur when the policy needs to be updated or has been miscalculated. For many companies, their business premises is often the highest-value asset. When was the last time you had your property officially valued? It’s essential that the valuation of your property is kept up to date and that your insurance provider is also aware. 

Over the last five years, the most common reasons businesses have claimed on their property insurance are fire and explosion, natural catastrophes, and faulty workmanship or maintenance. The effects of natural disasters cannot be overstated, given the climate crisis and the increase in catastrophes and their damage. 

‍What happens when a property is underinsured?

Whether a property is underinsured due to an out-of-date valuation, an insufficient index linking percentage or an unprecedented inflation rate, the result is the same: you are liable to pay out. 

In these cases, insurers would likely apply the ‘average clause’ in your policy, which means your settlement would be proportionally reduced in line with the percentage you are underinsured. 

For example, consider a building currently insured for £7.2 million. If the property were damaged in an earthquake, your insurance company would appoint a loss adjuster; in this example, they find the property in the current market to be valued at £9 million. This would mean that the property is underinsured by 20%.The repair costs are then calculated to be £5 million. Under the average clause, the claim payment is reduced by the amount of underinsurance, 20%, leaving the policyholder liable to pay £1 million.Rossborough’s parent company Gallagher recently reported that businesses that have not recently reviewed their insurance could be underinsured by 40% and, therefore, would have to pay out 40% of the reinstatement costs. What’s more, two-thirds of business leaders who own their premises say they haven’t reviewed their insurance in the past year, despite dramatic increases in costs associated with repairing properties.‍

How to prevent being underinsured‍

The most effective way to reduce the risk of underinsurance is to ensure that owned business property is regularly valued to ensure that your insurance policy accurately reflects your assets to best protect them. 

The Royal Institute of Chartered Surveyors (RICS) recommends that these are carried out every three years or earlier, in the case of significant alterations made to the insured property, with an annual adjustment to reflect inflationary effects.

While your property is likely your highest-value asset, the same logic can be applied to plant, stock, and equipment; it remains important that all your policies accurately reflect your sums insured and your business activities.

So, if you have made any structural changes to your property, increased your stock levels, purchased new plant or made changes to how you do business, you should let your insurance broker know straight away.

‍How can Rossborough help

‍Being part of Gallagher, one of the world’s largest risk management and insurance companies, combines local market knowledge with specialist expertise and access to global markets. 

One of the services we offer is an insurance review to ensure your cover is adequate for the needs of your business today, including a true reflection of your rebuild costs. Through partnership with an RICS-approved company, we can arrange for surveys and valuations whereby buildings replacement sum insured values can be provided.