Underinsurance is a significant issue in the commercial property insurance market, with many property owners unknowingly exposing themselves to severe financial risks. The consequences of being underinsured can be devastating, particularly when the average clause is applied to claims. Ensuring that your sum insured accurately reflects the cost to rebuild or replace your commercial property is essential to protecting your investment.
Underinsurance occurs when the sum insured on your policy does not adequately cover the full cost to rebuild or replace your property in the event of total loss. This often happens because of:
Rising construction costs: Increases in material and labour costs can quickly outpace your policy’s coverage, leaving you underinsured.
Outdated or inaccurate valuations: Failure to update property valuations regularly can result in sums insured that fall short of the actual rebuild cost.
Overlooked hidden expenses: Costs such as demolition, debris removal, and compliance with evolving building codes are often neglected but can significantly affect the overall cost to replace your property.
Some policies contain an average clause. This means that if you insure for less than the full value of the property, your claim may be reduced in proportion to the amount of the underinsurance. These clauses are also called co-insurance clauses.
Full (replacement) value: $1,000,000
Sum insured: $500,000
In this case, you would be self-insured for 50% of the full value.
If a claim is made:
Amount of claim: $100,000
Amount payable by insurers after applying average/co-insurance: $50,000 (i.e. 50%)
Some Business Interruption policies may also include an average/co-insurance clause, but the calculation differs. Typically, the Rate of Gross Profit, Revenue, or Rentals (as applicable) is applied to the Annual Turnover, Revenue, or Rentals (after adjusting for business trends or other factors).
Building materials, labour, and regulatory compliance costs have steadily increased, making older valuations often inadequate.
Commercial properties may feature specialised equipment, unique attributes, or tenant improvements, all of which can drive up rebuilding costs.
For properties held by Self-Managed Super Funds (SMSFs), underinsurance can lead to significant financial shortfalls, putting retirement savings at risk.
Any underinsurance gap becomes the property owner’s responsibility, potentially leading to severe financial hardship.
Conduct regular valuations to ensure your sum insured reflects current market conditions and building costs. Engage a qualified professional to perform regular valuations of your commercial property.
Include all costs to guarantee the sum insured covers demolition, debris removal, professional fees, and compliance with updated building regulations.
Adjust for inflation to keep your sum insured in line with rising costs over time by using policies with indexation or inflation adjustment features.
Understand the policy to ensure it meets your specific needs by working with your insurance broker to understand how the Average Clause applies to your policy.
Review policy annually to account for any changes to your property, including renovations, upgrades, or new features. Update your insurance each year.
Underestimated rebuild costs: A warehouse insured for $2 million was later valued at $3 million after a fire destroyed part of the building. Due to the average clause, the owner only received 66% of their claim, resulting in a $200,000 shortfall for repairs.
Failure to include compliance costs: A commercial office building required extensive upgrades to meet new building codes after a storm caused structural damage. These additional costs were not factored into the sum insured, leaving the owner with a significant financial burden.
A knowledgeable insurance broker is your best ally in avoiding underinsurance. Brokers can:
Conduct a detailed review of your policy and the sums insured.
Facilitate access to qualified valuation insurance professionals.
Ensure your policy includes necessary coverages, such as demolition and compliance costs.
Provide tailored advice based on your property’s unique requirements.
Don’t wait until disaster strikes to discover you’re underinsured. Protect your commercial property by ensuring your sum insured accurately reflects the full cost to rebuild and comply with current regulations. With the guidance of a trusted insurance broker, you can safeguard your investment and avoid costly surprises.
General advice warning: Note that policy terms and conditions apply.
AFSL Brokerage services provided by Findex Insurance Brokers Pty Ltd ABN 17 139 730 528 AFSL 342526
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