In today’s volatile economic climate, underinsurance remains a significant risk for Aussie businesses. Despite increased awareness over the years, many businesses, large and small, still find themselves inadequately covered, exposing them to substantial financial losses in the event of a disaster.
In this blog, we will explore the importance of avoiding underinsurance, the common pitfalls, and practical steps to ensure your business has the right level of coverage.
Why Avoiding Underinsurance is Crucial
Research shows that 12.8% of small businesses in Australia don’t have adequate insurance cover and 10% of small businesses are underinsured for their assets (Insurance Council of Australia)
The primary purpose of insurance is to provide financial security. Inadequate coverage can leave businesses vulnerable to significant out-of-pocket expenses, jeopardising financial stability.
We’ve noticed that economic challenges such as inflation, supply chain disruptions, and increased material costs have further highlighted the importance of adequate insurance coverage for many clients. As the replacement value of assets has risen, businesses need to reassess their policies to ensure they are still adequately covered.
Understanding Your Sum Insured and Its Connection to Underinsurance in Small Business
What is a Sum Insured?
The sum insured is the maximum amount an insurance company will pay out in the event of a claim. This amount is determined at the time the insurance policy is purchased and should reflect the true replacement value of the insured property or assets. The sum insured can cover various aspects, including:
Rebuilding Costs: The cost to rebuild a property from scratch.
Replacement Costs: The cost to replace damaged or lost items with new ones.
Additional Costs: Professional fees, debris removal, and other related expenses.
What is Underinsurance
Underinsurance occurs when the sum insured is less than the actual cost required to rebuild, replace, or repair the insured property or assets. This discrepancy means that in the event of a claim, the insurance payout will not be sufficient to cover the full extent of the loss, leaving the policyholder responsible for the shortfall.
How Underinsurance Happens
Underinsurance can occur due to several reasons:
Inaccurate Valuations: Not updating the sum insured to reflect current market values or replacement costs.
Cost-Cutting: Intentionally setting a lower sum insured to reduce premium costs.
Lack of Awareness: Not understanding the full scope of coverage needed, including all property elements and additional costs.
The Impact of Underinsurance
Underinsurance can have severe financial consequences:
Reduced Claims Payouts: Commerical Insurance often includes an underinsurance clause, which reduces the payout if the sum insured is found to be below a certain percentage of the replacement value (e.g., 80% or 85%). This means that the policyholder receives a proportionately reduced amount, which is insufficient to cover the full loss.
Out-of-Pocket Expenses: The shortfall between the sum insured and the actual cost must be covered by the policyholder, leading to significant out-of-pocket expenses.
Business Interruption: For businesses, underinsurance can mean extended downtime, loss of revenue, and potential bankruptcy if they cannot afford to rebuild or replace essential assets.
Example Scenario
Imagine a business that has insured its property for $500,000, but the actual cost to rebuild the property is $800,000. If the insurance policy includes an 85% underinsurance clause, the property should be insured for at least $680,000. Because the sum insured is only $500,000, the business is underinsured.
If a fire causes $250,000 worth of damage, the insurance company will apply the underinsurance clause. The claim payout will be reduced proportionately, resulting in the business having to cover a significant portion of the repair costs themselves. This financial strain could have been avoided with proper valuation and adequate sum insured.
Steps to Avoid Underinsurance
Accurate Valuation of Assets
Ensure that your insurance covers the full replacement value of your property, equipment, and other assets. This includes not just the market value but the actual cost of rebuilding or replacing assets as new. Having regular professional valuations helps keep your coverage accurate. Aim for an updated valuation every three years or whenever significant changes occur.
Include All Property Elements
Comprehensive coverage should include all aspects of your property, not just the main buildings. This includes parking lots, fencing, foundations, and any other structures or improvements.
Update Your Policy Regularly
Businesses are dynamic, and changes such as expansions, renovations, or new acquisitions should prompt a review of your insurance policy. Inform your insurer of any significant changes to ensure your coverage remains adequate.
Understand Policy Clauses
Familiarise yourself with the ‘Underinsurance’ clause in your policy. Typically, this requires your property to be insured for a certain percentage of its replacement value (e.g., 80% or 85%). Failing to meet this requirement can significantly reduce your claim payout.
Work with a Qualified Insurance Broker
Choosing an experienced broker, such as Macey Insurance Brokers, can provide invaluable advice and assistance in choosing the right policy and coverage level. They can assess your specific needs and help you navigate the complexities of insurance.
Final Thoughts on Underinsurance
Avoiding underinsurance is essential for protecting your business’s financial health and ensuring long-term success. By accurately valuing your assets, including all property elements, regularly updating your policy, understanding your policy clauses, and working with a qualified insurance broker, you can safeguard your business against unexpected events. In these tough economic times, proper insurance coverage is more important than ever.
Contact our expert team at Macey’s Insurance Brokers for personalised advice and assistance. We are here to help you navigate your insurance needs and ensure you are fully covered.
