By John Armstrong, director – executive MCL adjuster and Martha McGorman, commercial property adjuster
There are approximately 4.3 million small or medium-sized enterprises (SMEs) in the UK and alarmingly, around 80% are underinsured.
In addition, government research suggests that one in five businesses suffer a major disruption every year — with 80% of those affected closing within 18 months. There’s no avoiding the fact that while insurers and brokers can provide guidance in many ways, it’s the SME policyholder who really must engage with any potential underinsurance issues at policy inception.
Although it would be a mistake to assume that bigger businesses at the other end of the spectrum are getting their sum insured correct. Even the most experienced risk managers can find it difficult to gather sufficient detail and feel confident in the information they provide to insurers. With larger organisations that have multiple sites to cover, they will likely float sum insured coverage across those locations. The average is likely to apply only if the overall amount is insufficient – even if it’s too low for the individual site making a claim.
The issue as it relates to SMEs is less of a crisis and more of a persistent problem that goes back many years. It crystallizes when policyholders make a claim — taking several factors into account:
Duty of Fair Presentation Act
Underinsurance is every business owner’s nightmare. It can cause significant stress for employees, delays in agreeing repairs, difficulties in appointing contractors, a reduced final settlement and exacerbation of any BI losses — which may or may not be insured. In extreme cases, notwithstanding policies provide a contractual remedy for instances of underinsurance. In fact, the degree may be so great that it constitutes a breach of the Duty of Fair Presentation under the Insurance Act of 2015.
Average clause
At the risk of stating the obvious, the person in the best position to get the sum insured correct isn’t the broker or the insurer – it’s the policyholder. It’s unrealistic to expect insurers to appoint loss adjusters to comment on the adequacy of sum insured at policy inception. Not everybody makes a claim and investigating the adequacy of sum insured would push up premiums for all.
Insurers accept that getting the sum insured correct isn’t always easy, and most policies include an 85% average clause to allow for a margin of error. If a sum insured is 85% adequate or higher, the average will not apply. However, it would apply in full for 84% adequacy or lower. You only really know what a value at risk should be if everything burns down and must be replaced. For instance, a partial loss impacting two end bays of a large warehouse can be disproportionately expensive to repair and doesn’t necessarily relate to the adequacy of the sum insured for the entire building.
Improved policy wording
To avoid confusion, most policy wordings have been clarified in terms of asset definitions. The term ‘buildings’ usually doesn’t mean just buildings, but also includes car parks, roadways, perimeter walls, etc. They may also be based on how an average clause would be impacted if the sum insured is too low.
For some package policies, average clauses have been removed entirely and replaced with limits. However, these may still prove to be inadequate for an expanding business. Rates of growth for successful, smaller enterprises are likely to be greater than those of larger companies — further highlighting specific exposure for SME policyholders. Some insurers have also waived the average clause where business owners have commissioned and adopted the findings of professional valuers.
It’s not always clear whether an asset constitutes ‘buildings’ or ‘contents’. However, to avoid average applying — merely because insurers would ordinarily classify an asset differently to a policyholder — most policies contain an Accounts Designation clause, which accepts the policyholder’s classification.
Site surveys
As far as buildings are concerned, it’s beneficial to have a survey carried out on a reinstatement basis. While this is essential for historic and complex structures, it is worth considering for all types of buildings as the cost of the survey will be insignificant compared to the likely shortfall due to the application of the average.
Specialist valuers
Plant, machinery and contents valuers are also widely available – albeit policyholders may need pointed in the right direction by brokers or insurers. And it’s always beneficial to check that the retained expert has the appropriate skills, sector experience and references. They might not need to value the whole site. For example, if asset values are broken down over several buildings, a valuation for the largest or most complex site could be compared to the existing assumed values. That should pick up any significant discrepancy, for instance if a policyholder overlooked the cost of services such as power to machines or IT cabling.
Refer to accounts
Ironically, while a publicly filed set of accounts are somewhat useless when setting the sum insured, they can help sense check whether a contents sum insured is fatally low. On the balance sheet, the note for fixed assets will typically feature separate columns for buildings, plant and machinery and motor vehicles. Each column will show the cost at the beginning of the financial year and then again at the end of the year, plus or minus adjustments. Keep in mind that what you historically paid for a building is unlikely to bear any resemblance to its rebuilding cost.
One third higher
Empirically, when dealing with claims, we’ve found that the replacement cost for plant and machinery is typically one third higher than the historic cost recorded in the accounts – due to inflation, among other reasons. Alarms should go off if the sum insured figure is lower, especially if it’s below the historical cost.