In Depth: Underinsurance and the value of risk management

Underinsurance is a perennial problem for the insurance sector but, with the cost of living crisis putting finances under pressure, it’s set to become even more of a challenge. To prevent policyholders putting their livelihood on the line, the insurance industry must highlight the implications of underestimating cover requirements.

It’s a conversation that’s becoming increasingly common between brokers and their clients. “We are always highlighting the issue of underinsurance with our clients, especially around renewal,” says Josh Bedford, client director at Konsileo. “Cover must be regularly reviewed to ensure sums insured are accurate. If you’re not adequately insured, it’s not worth being insured.”

The scale of the problem can be seen in figures from valuation experts Barrett Corp & Harrington. Just over three quarters (76%) of the properties it has surveyed this year were underinsured, with an average valuation increase of 53% required.

And these averages don’t include some of the extreme outliers. “We’ve seen some cases where the level of increase required is in excess of 1000%,” explains Mark Briggs, managing director of Barrett Corp & Harrington, pointing to an historic hunting lodge that had its sum insured increased from £1m to £13m as an example. “Underinsurance has always been a big problem but policyholders are more at risk now than ever.”

Fuelling underinsurance

A broad range of factors are creating this increased risk. Issues with supply chains due to the pandemic, Brexit, and the war in Ukraine; rocketing energy and fuel costs; and unprecedented demand for labour and materials in the construction sector are all fuelling underinsurance. “It’s a once in a lifetime set of conditions,” says Chris Andrews, director of Aviva Risk Management Solutions. “The cost of construction materials is at a 40-year high and with a shortage of workers, in both construction and logistics, it’s pushing up reinstatement costs and indemnity periods. Where it might have taken one or two years to get back to a similar trading period, it will now take two or three.”

Rising energy costs are also contributing to higher reinstatement costs, as Neil Grimes, claims director at Clear Insurance, explains: “Increased energy costs mean the cost of running the equipment to dry out a property that has flooded is now three or four times what it was a year ago. All these additional costs add up and I wouldn’t be surprised if we start to see claims exceed insurers’ maximum sum insured soon.”

Cost of living crunch

Alongside these pressures, policyholders are also seeing their insurance premiums increase. Paul Steening, client director at James Hallam, says that alongside increases of around 10-12% as a result of index-linking, the hard market means that insurers are still pushing for rate, driving through premium increases in the region of 7.5%. “Each of these increases isn’t too bad on its own but, when they’re combined, it’s a double whammy,” he says. “We’re seeing some policyholders asking to remove the index linking but, given all the increased costs around construction, this uplift is absolutely crucial.”

With the economy struggling, it’s not surprising that policyholders are asking how they can keep insurance costs down. Many of the inflationary pressures that are driving up reinstatement values, for instance energy costs, wage increases and higher fuel prices, are also being felt by businesses and individuals.

This combination of factors is also driving underinsurance. Comparing this year’s figures from Barrett Corp & Harrington with those from 2019 shows that underinsurance is more of an issue now. While the amount of underinsurance is broadly similar – 78% in 2019 compared with 76% in 2022 – the average increase required is higher now. In 2019, the average sum insured required an uplift of 40%; this year, the figure is 53%.

Identifying underinsurance

Understanding where a policyholder could be under-insured and how this might affect them is key to preventing this problem. “It’s all about education,” says Andrews. “The rebuild value is only the starting point. Policyholders also need to consider how long it might take to get their business back up and running if everything needs to be replaced.”

Careful consideration of supply chains is essential. As an example, a factory with bespoke machinery must consider how long it would take to get this replaced in the event of a total loss, especially as the manufacturer itself may be reliant on a several suppliers, all of whom could be under pressure.

Supply chain failures was seen back in 2011 when the Japanese earthquake and tsunami affected the supply of electronic components and a similar crunch is currently being experienced as a result of the war in Ukraine. Bedford says that some of his clients have extended their indemnity periods to account for these types of factors. “A three-year indemnity period can seem excessive but where a client understands what might be involved with getting the business running again, it makes sense,” he says.

Longer indemnity periods are also essential for many of Steening’s property owner clients. “Materials and labour are taking longer to source,” he explains. “This pushes up the rebuild time but for clients with residential blocks, it will also increase the alternative accommodation costs. This often makes up the bulk of a claim so it’s essential to get sums insured and indemnity periods right.”

Getting it right

In the current economic climate, telling a client they are underinsured and need to increase their cover is not an easy conversation. Richard Graham, head of claims and risk management at Aston Lark, says it’s crucial though. “No one wants to be underinsured. As well as the danger that a claim won’t be paid there are issues around fair presentation of risk under the Insurance Act,” he explains. “Where we have a client with an investment property, they wouldn’t dream of putting their money into an investment that could lose them 20% to 30% overnight but that’s what they’re doing if they underinsure it.”

As well as educating clients about the risks of underinsurance, there’s a push from both brokers and insurers to help their clients get the right figures. As an example, Hayes Parson has been running a campaign to encourage more clients to get valuation surveys carried out. “Around six out of 10 of our clients found they were underinsured, with one in 10 overinsured,” explains James Woollam, managing director of Hayes Parson. “Having a survey is the only way to know that you have the right level of cover.”

Aston Lark is also promoting the importance of a professional valuation, working with a partner to launch a desktop valuation service in April. “It’s crazy to expect clients to know their rebuild value but neither is it enough to simply ask them to check it,” says Graham. “We also recognise that a full survey isn’t always appropriate: asking a client who pays £1,200 a year for building insurance to validate it with a £600 survey isn’t going to go down well. As a result, we launched this service, giving them access to a desktop valuation for £99.”

The good news is that this message does appear to be getting out there. While Aston Lark has already run more than 1,000 valuations for its clients, Barrett Corp & Harrington has also seen a significant uptick in the number of surveys. Back in 2019, it undertook 4,199 surveys: this year, it has already exceeded this figure, conducting 4,813 surveys by the end of July. “We are busier than ever,” says Briggs. “It is so important to get the sums insured right, especially given the current market conditions.”

Graham agrees. “No one can afford to sleepwalk into a situation where, if they need to use their insurance, they find out they’re underinsured,” he says. “There has to be certainty of outcome.”

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