The main purpose of business insurance is to provide a payout that is enough to cover the losses you’re claiming for. Underestimating this can be costly, as it could lead to a reduced payout from the insurer, or even no payout at all, with your business having to pay the difference.
According to the most recent Risk Insights Report from Aviva, one of the UK’s largest insurers, as much as half of UK businesses may be underinsured. Perhaps most alarming, two thirds think they have the right level of cover, which could be a dire miscalculation considering the reality of making up the shortfall.
“Ten per cent of SMEs [small to medium sized enterprises] said they would not survive if they had to pay up to £10,000 towards a claim that was not fully covered by insurance,” says Jason Chambers, Aviva’s head of Digital and Data Solutions, SME Trading.
Reasons why businesses may be underinsured
Underinsurance can happen if you don’t review an existing policy on a regular basis or reflect changes that happen along the way. This includes operational changes, such as diversifying into new areas or upgrading or moving premises, as well as economic factors that can affect how much cover you may need.
“Our research shows that 32% of SMEs do not take inflation or supply chain issues into consideration when reviewing their level of insurance, and 28% of SMEs have not reviewed their sums insured in the last year,” says Chambers. “This is leading to a growing problem for businesses.”
Amanda Walton, CEO of Enterprise Centres of Excellence at commercial insurance broker Marsh Commercial, explains that the reality for many busy business owners is that insurance is often the last thing on their minds.
“An example is a small business that had a retail shop on the high street and during the pandemic, when footfall fell, they realised that they could sell nearly as much online as they did out of their shop,” she says. “Now, they need fewer employees and different distribution. The last thing they want to think about is changing their cover or informing their insurer. It just isn’t the first point in their mind for the majority.”
What happens if you are underinsured?
The answer is simple: your business would have to make up the difference. This may mean footing the bill for anything from replacing stolen stock or equipment to repairs to damaged premises.
Aviva estimates that 40% of business policies that include buildings cover are underinsured by 20% for at least one of their premises. This can be a real problem if insurers use what’s known as the ‘average clause’, which means they would only pay out the percentage of a claim that you are actually insured for.
So, say you have a buildings insurance policy that covers 60% of the real rebuild cost. The insurer would set the average clause at 60%, so a claim for £80,000 of damage would result in a restricted payout of just £48,000.
It’s worth mentioning that honesty and accuracy are crucial. If an insurer thinks you’ve purposely given misleading or incomplete information at any stage, your policy could be made void and you may not receive any payout at all.
The impact of inflation
To keep up with changing costs and economic conditions, property cover is usually index-linked (also called indexation) in line with a measure of inflation, such as the Consumer Prices Index (CPI). Business insurers also use the Building Cost Information Service (BCIS) for up-to-date information on rebuild costs for commercial premises. This means the insurer automatically reflects changes to the price of raw materials and labour, and the cost of living, in your cover amount at renewal time.
However, there is a risk in relying on index-linking alone. “It’s important to remember that unless a property has had a reliable valuation on which to base the policy, increases in levels of cover through indexation will not account for the significant number of properties that were never correctly valued for insurance purposes,” Chambers tells NerdWallet. “Therefore, these increases in cover will do little to make up for the low valuation compared to the actual rebuild cost.”
Chambers also cautions that “indexation is based on average material and labour costs and does not reflect nuances with different types of building construction, nor their specific circumstances”.
It’s not just a property problem
It’s also worth knowing that inflation doesn’t only affect rebuild costs or the value of your insured contents. Increased turnover can also affect your cover.
Businesses may choose to absorb the increased costs that inflation brings, but in reality, as Walton explains,“The majority pass it on to the customers, and what does that do? It puts their turnover up, which means they haven’t got the right cover, or are not covered for the turnover.”
This is because changes to your turnover can affect how much cover you need and the premium you pay. That’s why insurers ask about your annual turnover when they work out the price of your cover.
One type of cover where income is central is business interruption insurance. Your sum insured needs to reflect lost income for an agreed indemnity period (such as 12 months) if you are unable to carry out business as usual after something goes wrong, such as essential equipment failure or a fire. So not having cover in line with your turnover could mean you have less financial support than you need. What’s more, supply chain issues can affect how long you might need to receive support for lost income, so getting the indemnity period right is important too.
So instead of setting cover and forgetting about it, you need to be “matching the cover to the risk of the business”, says Walton, which can change over time.
Ways to prevent underinsurance
There are ways to help make sure you don’t find yourself unintentionally underinsured.
Revisiting your cover levels regularly should form part of a business continuity plan. Not only before renewal, but after any changes, such as purchasing specialist equipment, changing distribution methods, hiring employees or diversifying into new areas. Walton says that during the pandemic, “Not many industries didn’t change their model, or adapt or pivot.” And with that, they may have “fundamentally changed their risks”.
Chambers reiterates that timely reviews are key: “While a policy review can be done at renewal, clearly if a business has not updated or reviewed their sums insured for a while (three years or more), they shouldn’t really wait until renewal – they should speak to their broker now.”
If all this seems less than straightforward, a broker can help guide you. Walton believes that the “systemic, historic challenge” of underinsurance can be helped by brokers regularly engaging with policyholders about any changes. But there also needs to be an appreciation of the daily challenges SMEs face, such as “worrying about getting their stock out, getting the money in, paying their employees,” which all leave little time for thinking about insurance.
But you’re unlikely to regret setting the time aside to think about insurance. Scheduling an hour or two to review your cover is crucial, considering the potential alternative of making up a hefty and unaffordable shortfall.
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