Many companies find their sums insured are inadequate when they make an insurance claim. Consequently they do not receive the insurance payouts they expect.
Could you be one of these companies?
Our regulator in the insurance industry is the Financial Conduct Authority (FCA). The following statistics from an FCA thematic review, “Handling of insurance claims for Small and Medium-sized Enterprises (SMEs)” demonstrate some alarming facts:
• 20% of SMEs are probably underinsured.
• 50% is the proportion that some SMEs are underinsured by.
• 40% of business interruption (BI) policies are probably underinsured.
• 45% is the average insurance shortfall of Business Interruption policies.
If a company is found to be underinsured, insurers typically apply the condition of average to the claim settlement. In practice, this results in the claim settlement being proportionately reduced according to the degree of underinsurance.
Imagine a building was insured for £500,000 and a fire causes £200,000 of damage to that building. If that building’s replacement value was £1,000,000, the insurer will judge that the building has only been insured for half of its real value. It will therefore reduce the payment by half, to just £100,000.
Business interruption (BI)
BI insurance policies are especially prone to underinsurance because of difficulties in determining:
The sums to insure – there is often a big difference between the technical meanings for words in a policy and how words are used in everyday business. For example, the definition of ‘gross profit’ in a BI policy is different from that commonly used by accountants.
The timeframe the policy should cover - known as the ‘indemnity period’, which needs to be long enough for the business involved to return to a similar financial position as it was in immediately before the insured event (e.g. a fire or flood) occurred.
Underinsurance occurs frequently in property insurance. Sums insured need to be sufficient to cover the full reinstatement value of the assets insured. But companies often insure physical assets as they are listed on their asset register – not realising that the values are based on original cost or depreciated figures, rather than current day prices. Actual replacement costs can be much greater than this.
Similarly, some property owners might decide not to insure their property for the cost of rebuilding on a like-for-like basis because in the event of it being destroyed, they would not intend to rebuild the property in the same manner as before.
However, most damage to properties is ‘partial’ rather than ‘total’, in which case the property has to be repaired like-for-like to be consistent with the undamaged portion. Also, some properties (e.g if they are ‘listed’) or local authority requirements place obligations on the owner to reinstate the building exactly as before in the event of its destruction.
It is worth spending time with your insurance broker to understand your business risks and the full value of the assets you want to insure and any perils you wish to insure against. This process will help you in any subsequent claim settlement. If you would like further information on managing and mitigating business risk or arranging/placing your insurance cover please contact me.
For more information, or to discuss your insurance and risk management needs, contact Sally Swann, JLT Specialty Ltd, 45 Church Street, Birmingham, B3 2RT. Tel 0121 633 3377, visit www.jltspecialty.com or email Sally_Swann@jltgroup.com
Lloyd’s Broker. Authorised and regulated by the Financial Conduct Authority. A member of the Jardine Lloyd Thompson Group. Registered Office: The St Botolph Building, 138 Houndsditch, London EC3A 7AW. Registered in England No. 01536540. VAT No. 244 2321 96.
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