Being underinsured means a property owner does not have enough insurance coverage to fully cover the cost of repairing, rebuilding, or replacing their property after a loss. This can have serious financial consequences.
Some of the main dangers include:
- Large out-of-pocket costs
If the cost to rebuild or repair the property exceeds the insurance limit, the owner must pay the difference themselves. - Reduced claim payouts
Many insurance policies include an "average" or "coinsurance" clause. If the property is underinsured, the insurer may reduce the payout even for partial losses, not just total losses. - Difficulty rebuilding after a disaster
Rising construction costs, labor shortages, and inflation can make rebuilding much more expensive than expected. An outdated insurance amount may leave the owner unable to restore the property to its previous condition. - Financial hardship
Property owners may need to use savings, take out loans, or even sell assets to cover uninsured losses. - Mortgage complications
If the property is mortgaged, the lender may require adequate insurance. Insufficient coverage could breach the mortgage agreement or leave the owner owing the mortgage on a damaged property. - Business interruption (for commercial properties)
Underinsured commercial property owners may not have enough coverage to repair premises quickly, resulting in lost income, ongoing expenses, and potential loss of customers. - Liability for code upgrades
After significant damage, rebuilding may need to comply with updated building regulations. If the policy doesn't adequately cover these additional costs, the owner must pay them.
Example
A building is insured for £400,000, but the actual rebuilding cost is £600,000.
- A total loss leaves the owner £200,000 short.
- If there is a £120,000 partial loss and the policy includes an average clause, the insurer may only pay:
leaving the owner to pay the remaining £40,000.
How to reduce the risk
- Review insurance cover annually.
- Base the sum insured on the full rebuilding cost, not the market value of the property.
- Update the policy after renovations or extensions.
- Account for inflation in construction costs.
- Consider policies with index-linking or guaranteed replacement cover where available.
Regular reviews and accurate valuations help ensure the insurance remains sufficient as rebuilding costs change over time.