After cyclones, floods and other natural catastrophes, concerns often focus on businesses and residents that either don’t have insurance or have cover well below the levels needed to repair the damage.
There are many potential reasons for this in a difficult insurance market, including conscious decisions by the client to accept more risk or to avoid the expense of covering something offered as an option, such as flood.
But many businesses risk leaving themselves open to underinsurance by simply not realising how decisions taken to save some dollars on premiums can have much larger consequences.
As SMEs expand and diversify their operations underinsurance can occur when policies are not updated to reflect the new circumstances. Community and regulatory changes can also have an impact. For example equipment may have been purchased in a growth phase or plant upgraded. Stricter construction standards in cyclone and bushfire-prone regions may have increased building expenses, and previous sums insured may be insufficient.
The Insurance Council of Australia says best practice suggests a property is underinsured if a policy covers 90% or less of the rebuilding costs.
A less well-known pitfall occurs when a business calculates that premiums can be lowered with limited downside by taking out insurance for a sum that is less than the true value of the property being covered.
In those cases, policyholders often expect a deliberately underinsured total sum will still provide full cover for any partial damage or lesser impacts that may be more likely to happen.
But that’s not always how it works. Many insurance contracts have average or co-insurance clauses that proportionately reduce the sum paid out for partial damage, reflecting the degree of underinsurance that has been applied for the total value.
If only one room of a building is damaged and the contents of that room destroyed, an underinsurance adjustment would mean only part of the recovery cost would be paid out after the claim.
Often the clause will apply if total values declared are less than 80-85% of full replacement, providing a margin for some normal fluctuations and errors before the equation takes effect.
The clauses highlight the importance of having correct valuations for insurance purposes and the financial risks triggered by decisions to take out cover for less than the full value.
Large-scale natural disasters often highlight underinsurance problems, but the issue is widespread and tends to fly under the radar for isolated and partial damage claims. Often it emerges when a property fire breaks out, perhaps due to electrical faults or after café or restaurant kitchen accidents.
It can be devastating at those times to realise the payout you expected isn’t in place. So please, discuss the underinsurance pitfalls with us so you’re aware of the potential risks.