Underinsurance is not a new issue within the insurance sector, however the gradual shift from a soft market into a hard one has ramped up the potential risks for business owners who find themselves without adequate cover.
Rebecca Fuller, head of fixed asset management and insurance solutions, Europe, Middle East and Africa (EMEA) at financial consultancy firm Duff and Phelps, explained: “It is now a sellers’ market, with insurers having more control in dictating pricing, terms and conditions.
“We have seen that the risks associated with not having justifiable adequate values are above market rate increases, declining to renew coverage, or having a valuation undertaken being made a condition to the policy.”
A further risk Fuller identifies is “average being written into the policy”. Mark Pierce, operations director at Criterion Adjusters, said “this allows Insurers to reduce the claim by the same percentage level of the underinsurance. Put simply, if your sum insured is 50% of your actual value at risk, you will only get 50% of your claim paid”.
Pierce added that an average clause is now a feature on many domestic and commercial policies, providing a tool that insurers can impose if underinsurance is evident.
SMEs are in particular danger when it comes to underinsurance. “Many SME businesses are family run from a single location - they do not have the level of capital reserve, risk management or financial advisory resources which readily exist in the larger firms,” Fuller said.
“They ultimately rely on advice which will ensure that their insurance does its job in responding how they expect it to in the event of a claim.”
The switch from a soft to hard market could also impact insurers when it comes to underinsurance, continued Fuller.
She said: “In a soft market cycle, insurers have not placed pressure on insureds. An abundance of capacity and choice in a soft cycle, combined with a serious lack of data to support the issue of underinsurance, means insurers could risk losing their customers.”
Cause and effect
There are many reasons why a business may be underinsured. For example, acquisitions can bring new assets and information to a business, but these details are not always accurate or considered for insurance purposes. Companies may not have ever had a valuation, so they “merely add on an inflationary percentage, thinking that may cover it”. Furthermore, “with the rise of insurtech and a vastly shrinking capacity, insurance companies are looking for cleaner and better managed risks to cover”, Fuller added.
Valuation services themselves could also be to blame for underinsurance. Fuller explained: “Many valuation businesses have archaic ways of working and inflexible methodologies. This combination can lead to the cost of a valuation being prohibitive for the client, certainly with SME businesses.”
Pierce, on the other hand, identifies three main strands to underinsurance, adding that around one in five property risks have a form of underinsurance.
The first is deliberate underinsurance “in an effort to manage the cost of risk and insurance premiums”.
“Here they are essentially accepting part of the risk themselves should a claim arise,” Pierce said. Fuller agreed: “Back in the day, the lower your insurable value, the lower your premium - so why change that?”
The second cause of underinsurance is purely accidental. Pierce explained: “This occurs when, despite every effort to set the correct cover, something happens that means the values set are too low at the time of a loss. An example might be when a large one-off delivery of stock has been made and a claim occurs directly after that delivery.”
The third main cause of underinsurance, according to Pierce, is inadequate advice. “Some types of cover can be difficult to properly evaluate,” he said. “If the right questions are not asked of the right people and assumptions [are] made, then sums insured can be set that are erroneous and sizeably less than the true value.” It is this area that poses a particular peril to the broking sector.
Fuller believes that legal recourse could be the solution to underinsurance, working in conjunction with “regular valuations, good information and great communication between valuation firms and the insurance industry”.
She explained: “Businesses in Saudi Arabia and Italy are required by law to have regular valuations for insurance purposes. Although this has had a negative impact on the pricing of valuation services, the insured businesses are confident in their declarations to carriers. More importantly, these businesses are at next to no risk of being underinsured should they suffer a loss.
“Making an independent review mandatory every three years or so would take away a lot of the uncertainty on both sides of the fence and support the Insurance Act - surely a win-win?”
Against this backdrop, what can brokers do to ensure their commercial clients are not underinsured?
For Fuller, it comes down to having “more in-depth discussions around the values and the consequences of underinsurance”. This includes being armed with relevant sector statistics that brokers can use to help demonstrate their point.
“Our latest study showed that out of 1,504 buildings in the UK, which we valued in 2019, 71% were underinsured by 25% or more; the percentage of those properties being underinsured by 100% or more was equally as staggering. Brokers should draw on factual data like this and use statistics to support them in their quest to give a better breadth of advice,” she explained.
Pierce agreed, recommending that brokers build “a comprehensive profile of the insurable risk at new business and renewal stage” based on detailed conversations between the broker and client.
He continued: “Certainly, between renewals a lot can change with a risk and index linking alone may not be adequate.
“More or improved property [and] equipment is purchased, buildings are extended, or a business becomes more successful and all of these changes need to be woven into a revised risk profile. If the depth of those discussions is insufficient, underinsurance can arise.”
Brokers that fail to take the lead here may find themselves facing difficulties. For example, Pierce added that “serious cases of underinsurance can lead to situations where brokers are pursued for any losses that the policyholder cannot recover from their insurer.
“This may result in a claim against the broking business, which may lead to them presenting a professional indemnity claim to their insurers. Any such claim against the business will have a financial and reputational impact on that broker that all would want to avoid.”
Fuller added that brokers may also find themselves on the back foot as forward-thinking insurers opt to tackle underinsurance.
“As the insurance market has firmed, we have seen a significant shift,” she said.
“We are now seeing multiple global insurers request us to review the adequacy of values across their underwriting portfolios. These forward-thinking insurers may know which clients may have an issue with underinsurance even before their brokers send in underwriting submissions.”