Business underinsurance happens when the sums insured on a policy are lower than the true cost of putting things right after a loss. It is one of the most common problems insurers and brokers see, and it rarely shows until a claim is made. By then, the business may find that the insurer pays only part of a claim, even for a small fire or flood.
This autumn, trade reporting has pointed to a mixed picture for established firms. Commercial insurance rates have eased for many well managed risks, but rebuild costs, stock values, wages and turnover have kept rising, and insurers are increasingly asking for evidence behind the figures declared. This guide explains why that matters, how to check your own figures before renewal, and what to ask your broker.
Why underinsurance is back in the headlines
Several pressures have come together at once, and most of them push the true value of what a business owns upwards.
- Rebuild costs keep climbing. Materials and skilled labour cost more than they did a few years ago, and small annual index increases on a policy often do not keep pace.
- Tighter standards apply after a loss. A building damaged today usually has to be rebuilt to current fire safety, building safety and energy efficiency standards, not to the standard it was first built to.
- Values have grown without anyone noticing. Extensions, new fit-outs, machinery and extra stock add value that is often never passed on to the insurer.
- Lower rates tempt firms to trim cover. When budgets are tight, it is tempting to keep the premium down by leaving sums insured where they were. Brokers warn that this simply stores up trouble for the next claim.
Industry commentators have also made a point that surprises many owners: the biggest risk is often not a total loss but a partial one. A small fire, a burst pipe or a break-in is far more likely than losing a whole building, and those are exactly the claims that get reduced when the figures are too low.
How average can cut a claim
Most commercial property policies include a condition known as average. If the sum insured is lower than the true value at the time of the loss, the insurer may reduce the claim in proportion. A building insured for half of what it would cost to rebuild may see a claim paid at roughly half, even if the damage is only to one room.
Average does not wait for a total loss. It can apply to every claim, large or small, if the figures on the schedule are too low.
Some policies apply average only when the shortfall is above a certain margin, and some sections are written without it. The detail varies between insurers, so it is worth asking your broker exactly how average applies to each part of your cover.
The figures to check before renewal
Underinsurance is not just about buildings. Every section with a sum insured or a limit deserves a fresh look. The table below sets out what each figure should represent and where the gaps usually appear.
| Figure | What it should cover | Common gaps |
|---|---|---|
| Buildings | The full cost to demolish, clear the site and rebuild to current standards | Using market value or purchase price instead of rebuild cost |
| Professional fees and debris | Architects, surveyors, planning and site clearance | Assumed to be included when they are not |
| Tenant's improvements | Fit-out work a tenant has paid for in a leased unit | Left out because the landlord insures the building |
| Machinery and equipment | The cost of replacing items with new equivalents | Figures based on book value after depreciation |
| Stock | The value at the busiest time of year, not the average | Seasonal peaks and new product lines |
| Business interruption | Lost gross profit and extra costs over a realistic recovery period | Gross profit taken straight from the accounts, or an indemnity period that is too short |
Buildings: rebuild cost, not market value
The buildings sum insured should reflect what it would cost to rebuild, which can be very different from what the property would sell for. Specialist construction, older materials and complex services all add cost. A professional rebuild cost assessment every few years, and after any major alteration, is the most reliable way to set the figure. For older and protected buildings, our guide to listed building insurance explains why specialist valuations matter even more.
Owners with several sites should keep one register of rebuild values, valuation dates and renewal dates across the whole estate. Insurers arranging property portfolio insurance usually expect to see this, and it makes gaps far easier to spot.
Contents, machinery and stock
Most policies pay to replace equipment with new items, so the sum insured should reflect replacement cost rather than the written down value in the accounts. In offices, the value of IT, furniture and fit-out is often higher than expected; our guide to office insurance covers what usually needs to be included. For factories and workshops, plant and machinery can be the largest single figure on the schedule, which is why manufacturing and engineering cover is normally built around a detailed asset list.
Stock levels change through the year. Retailers and wholesalers who build up stock before busy seasons should check that the sum insured covers the peak, or ask for a seasonal increase. Our shop insurance guide covers how stock is usually insured on retail premises.
Business interruption: profit and time
Business interruption is where underinsurance is often largest and least understood. Insurers define gross profit in a particular way, and it is frequently higher than the figure in the accounts. The indemnity period also needs to be long enough to cover rebuilding, re-equipping and winning back customers, which can take longer than many owners expect. Business interruption insurance can sometimes be arranged on a declaration linked basis, which gives some protection against getting the estimate wrong.
Practical steps to take this renewal
- Start early. Ask for your renewal documents well before the renewal date so there is time to review the figures.
- List every site, building and section of cover, with the sum insured and when each figure was last checked.
- Arrange a rebuild cost assessment for any building that has not been valued recently or has been altered.
- Update asset registers for machinery, IT and equipment using current replacement prices.
- Check stock values against your busiest period, not the year end.
- Work through the business interruption figures with your accountant, using the insurer's definition of gross profit.
- Tell your broker about any extensions, refurbishments, new equipment or changes in how the premises are used.
- Keep a record of how each figure was calculated, in case the insurer asks for evidence.
If you are planning building work, tell your insurer before it starts. Works can change both the value of a building and the risk, and larger projects may need separate renovation cover while the work is under way.
What insurers expect to see
Insurers are increasingly unwilling to accept round numbers or figures that have simply been increased by an index each year. Many now ask how a sum insured was reached and when it was last professionally checked. Points that usually help:
- A recent rebuild cost assessment for each building, especially larger or older properties.
- An up to date asset list for equipment and machinery, with replacement values.
- Business interruption figures that match the insurer's definition of gross profit, with a clear indemnity period.
- Clear notes on any tenant improvements, shared parts of buildings and who insures what under each lease.
- Prompt notice of changes during the year, rather than waiting for renewal.
Landlords should check that the building sum insured and loss of rent cover both reflect current values; our guide to commercial landlord insurance covers how this usually works in let buildings. Firms that own and occupy their premises often find that a single commercial combined policy makes it easier to keep buildings, contents, stock and interruption figures consistent.
Is overinsurance a problem too?
Yes, although it is less common. Some businesses insure buildings for their market value or include items they no longer own, which means paying for cover that would never be paid out. Getting the figures right works in both directions: it protects claims and avoids paying for value that is not there. A well evidenced commercial property insurance schedule is usually the starting point for both.
Frequently asked questions
How often should a business get a rebuild valuation?
Many surveyors and brokers suggest a full rebuild cost assessment every few years, with index linking in between and a fresh valuation after any major alteration. Larger, older or unusual buildings may need checking more often.
Does index linking stop underinsurance?
It helps, but only if the starting figure was right. Index linking adjusts the sum insured each year, but it cannot correct a figure that was too low to begin with, and it may not keep pace when building costs rise quickly.
What is a day one basis?
Some buildings policies are written on a day one basis, where the declared value is set at the start of the policy and the insurer allows an uplift to cover cost increases during the policy year and any rebuilding period. It can reduce the risk of average applying, but the declared value still needs to be accurate.
Will raising my sums insured increase my premium?
Usually it will, at least a little. Many brokers point out that, in a market where rates are easing, correcting the figures now can cost less than it would in a harder market, and it protects every future claim.
Accurate figures are the foundation of every business policy. For more on protecting profit, premises and the people who run the business, see our business protection insurance guides.
Sources and further reading