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The unseen cost 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.
It’s one of the most important question we ask new clients, because when it comes to valuing assets, the temptation to undervalue often presents itself. As one 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.
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 proportionately lower level.
Take the scenario of a property that is covered for $50,000, when the correctly calculated value would be $100,000. The policyholder might think partial damage worth, say, $50,000 would be fully covered as it falls within the sum insured level.
In reality, only $25,000 would be paid to the business owner, as the 50% underinsurance rate would also be applied to claims for partial loss or damage.
The approach helps underwriters to 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.
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%.
In the case of business interruption, insurable gross profit should also be covered for the full value, and there is often little tolerance for error here, particularly in areas such as standard industrial special risks.