Recent findings from a surveyor firm underlined a concerning issue in the UK’s property insurance landscape. It highlighted that a significant number of property insurance policyholders (approximately 82% for residential properties) may be at risk of ‘underinsurance’[1]. An additional report conducted by the surveyor firm Barrett Corp and Harrington echoes these concerns. Their statistics reveal that a surprising 77% of their clients’ buildings are incorrectly insured. On average, these properties required an increase in their insured values by around 36%.
In this article, we will look at what underinsurance is, explore the reasons behind it, its potential consequences, and offer insights on how to steer clear of this financially perilous situation.
What is Underinsurance?
Underinsurance, particularly in respect of property insurance in this article, occurs when an insurance policy fails to provide adequate coverage to meet the expenses incurred following property loss or damage. In essence, your insurer would end up paying less than what you need to cover the costs arising from the damage, potentially leaving you with a significant financial gap to bridge. It’s crucial to emphasise that the responsibility for declaring and maintaining sufficient sums insured ultimately lies with the policyholder.
Causes of Underinsurance
To avoid underinsurance, it’s essential to insure your property for its correct ‘reinstatement cost’—the amount required to completely reconstruct the property in the event of a total loss. This figure includes construction costs, material expenses, demolition, site clearance, professional fees, and, where applicable, Value Added Tax (VAT). It’s vital to differentiate that the reinstatement cost differs significantly from the ‘market value’ of the property. Unfortunately, many property owners continue to make the costly mistake of insuring their property based on its market value rather than the rebuild cost.
Furthermore, factors such as the impact of the Covid-19 pandemic and events like Brexit have contributed to significant increases in building material and labour costs across the UK. Consequently, the rebuild sum insured on your policy may have become outdated and no longer accurately reflects the correct sum insured.
Implications of Underinsurance
So, what if you need to make a claim and it’s determined that your property is underinsured?
Most insurance policies include a condition known as the ‘Average clause’. This allows your insurer to proportionally reduce the claim payment based on the percentage of underinsurance. For instance, if it costs £200,000 to rebuild your property, but you have elected to insure it for only £100,000 (which represents 50% of its actual rebuild value), the insurer can reduce the claim settlement by 50%. In a total loss scenario like a severe fire, the policyholder may only receive a £50,000 claim settlement from the insurer (50% of the initial insured amount of £100,000) leaving a substantial balance to be covered by the property owner.
Preventing Underinsurance
To help prevent underinsurance, it’s advisable to follow guidance provided by the Royal Institute of Chartered Surveyors (RICS). They recommend conducting a comprehensive review of your property’s reinstatement value every three to five years, or sooner if property alterations have been made. This entails arranging for a Reinstatement Cost Assessment (RCA) survey conducted by a qualified surveyor. Alternatively, policyholders can opt for a more cost-effective option, a ‘desktop survey.’
Another essential practice is ensuring that Index Linking is applied to your declared values at each renewal; an Insurer provision to adjust your building’s sum insured to account for inflationary increases in building costs, materials, and labour.
In conclusion, underinsurance can be costly in the event of an unforeseen incident. Therefore, it is vital to address this issue promptly to ensure your property is adequately covered.
If you would like to discuss your policy and the insured sums specified therein, please do not hesitate to contact Howden. You can contact us here or email Jamie, our Property expert, at Jamie.McKenzie@howdeninsurance.co.uk.
