Given the financial impact of 2020, it’s more important than ever to check for overinsurance and underinsurance, especially in the commercial insurance world. Here, we look at the contributing factors, and potential consequences of incorrect insurance sums insured.
When disaster strikes, having the right level of insurance cover is essential.
Nick Hobbs, Director of Broker Markets at Allianz Insurance plc. said:
“Given all the changes and uncertainty that businesses have experienced in the last few years, and particularly in 2020, it would not be unusual for the level of cover to be out of line with their fluctuating needs. On top of that, when the economy is struggling, that risk of underinsurance is exacerbated.”
Covid-19 Uncertainty
The Covid-19 pandemic can be one of the main contributing factors. After a year of many businesses seeing their profits adversely affected, some will now be struggling.
As well as potentially leading to some businesses reducing their insurance to cut costs and buying fewer covers, the uncertainty around operations makes it difficult to assess insurance needs accurately. This is particularly the case for insurances such as business interruption and liability, where limits are based around financial data such as turnover, gross profit and payroll.
Alastair Blundell, Head of Insurance at the British Insurance Brokers’ Association said:
“Having a business closed because of lockdown, or with most of its employees on furlough, will drastically affect these figures now, but perhaps not as we go forward. It is key to reassess wage and turnover figures where these need to be declared to insurers, but also how long the indemnity period needs to be, bearing in mind current trading conditions.”
For instance, if, during the pandemic, a company has not performed as well as it has previously, it may have reduced its sums insured in line with current performance. But, with the economy predicted to grow again, resulting in an increase in sales, the company needs to ensure its sums insured reflects this. Otherwise, there could be a shortfall when the time comes for them to claim.
Underinsurance can also occur where businesses have reinvented themselves during the pandemic. These reinventions can take many forms, including restaurants moving into deliveries and retail businesses supplementing their bricks and mortar outlets with online stores.
While resourceful, these shifts will have affected risk and insurance requirements. For instance, where restaurant staff are delivering food, are their vehicles insured for that purpose? And where a shop goes global by being online, do they have sufficient liability cover if something goes wrong with one of its products overseas?
Brexit Barriers
With the Brexit transition period having ended on 31st December 2020, the new year sees the UK take its first steps outside the EU. While this will mean that businesses that trade with other countries, will need to get to grips with new regulations as it could also affect every business’s insurance requirements.
Stockpiling has been on the insurance industry’s radar for some time, as concerns about the availability of goods and materials from the EU resulted in some businesses increasing the level of stock they held. Taking this action may safeguard the business if issues arise around supply chains but it is also essential that this additional stock is considered when arranging insurance.
Issues with supply chains may also need to be factored into indemnity periods. If it takes longer to get stock or machinery, it would be prudent to take this into consideration when setting the indemnity period on business interruption.
Insurance Industry Issues
Businesses’ perceptions of the insurance industry can also influence the likelihood of underinsurance. In 2020, although there were plenty of examples of insurers and brokers supporting their clients, the industry’s reputation was affected by the disputes on business interruption.
As businesses were forced to close, many reached for their business interruption policy only to find that, on most, pandemics were not covered. While this exclusion was clear-cut on most policies, others had more ambiguous wordings, with the Financial Conduct Authority bringing a test case to clarify contractual uncertainty for policyholders and insurers.
Malcolm Tarling, a spokesman for the Association of British Insurers said:
“Despite paying out over £900 million in business interruption claims to firms covered against a pandemic, there is no doubt that the reputation of the industry has taken a hit as a result of the disputes surrounding the scope of cover provided by some business interruption policies. Some businesses may even be questioning whether to bother with insurance where their policies didn’t respond to the pandemic. It’s important to remind those businesses that insurance isn’t designed to cover a pandemic – the scale of such losses would require government support – but it can cover risks such as fire, flood and theft, that can, and do, regularly affect businesses, and in which insurers pay out millions of pounds in claims every day.”
Underinsurance as an Issue for Business
Although research suggests underinsurance is incredibly common, taking out less cover than is required can have severe consequences for a business. In the event of a loss, it can find itself seriously out of pocket if underinsurance becomes apparent through the claims management process.
Where a business is underinsured, the insurer can apply the average clause. With this, if the insurer finds the business has taken out inadequate insurance, it can reduce the settlement by the same percentage the asset is underinsured.
For example, an insured has an annual turnover of £1 million with £600,000 gross profit. They took out a business interruption policy, with a sum insured in line with the £600,000 gross profit.
However, as the policy was written on a 24-month indemnity period, this meant the sum insured applied to two years, meaning they were only 50% covered. The business suffered a loss and made a claim for £200,000 to cover the four months it had to cease operating. As the policy had an average clause, the claim was reduced by 50%, and the insured only received £100,000. This is a situation no business wishes to find themselves in.
Under the Insurance Act 2015, policyholders have a duty of ‘fair presentation of risk’, which requires them to disclose every material circumstance they know, or should know. If an insurer believes a policyholder’s underinsurance is the consequence of a ‘deliberate’ or ‘reckless’ breach of this duty, it is within its rights to void the policy altogether, with no return of premium. It may even look to prosecute if it believes the sums insured were deliberately understated.
Preventing Underinsurance
- Getting the right cover
Appoint a broker to help with the uncertainty. A broker has trained professionals to look at your unique circumstances, and in many cases, visit the business to perform an on-site, face-to-face review of your bespoke requirements.
- Get a professional valuation
As rebuild costs can be hugely different to market values, it is worth having properties valued by a professional to ensure sums insured are accurate. The sum insured also needs to take into account additional expenses such as architects fees, any public authority or planning costs and, where necessary, VAT.
- Ensure accurate sums insured
An up-to-date inventory can help set the right sum insured. This needs to take into consideration everything in the premises, including customer goods where this is the case. It should also reflect peak stock levels, rather than the average.
- Check definitions and sums insureds
Accountancy and insurance policy definitions of annual gross profit differ, so businesses need to make sure they have set their sum insured in line with the policy wordings. It’s also important to set the sum insured in line with expected costs and profits, which may include growth or recovery from 2020’s level if the business was adversely affected by Covid-19.
- Get the right indemnity period
Many businesses underestimate how long it will take to fully recover their trading level after a loss, with many opting for a 12-month indemnity period rather than a more generous – and more realistic – 24-month one. This can be the case particularly where a business is in an historic or unusual building that may take longer to rebuild, or it has specialist equipment that can take time to replace.
- Assess limits of liability
Consider the risk of claims that could be brought against the business. These can evolve over time and may also change, for instance where a business has taken on new liabilities under a terms of business contract. Keeping an eye on trends in liability claims will help to keep businesses protected and insurance cover at the right levels.
- Identify cover gaps
Businesses need to check their cover remains in line with their activities. New risks emerge, (such as cyber risks) and some businesses may have ventured into new areas as they adapted to the pandemic.
