Updated: 29 April 2025
Exploring Underinsurance - finding the balance
In today's evolving economic environment, with adjustments in taxes and legislative updates, business owners are navigating a range of new dynamics. Against these conditions, it’s more important than ever to ensure the business has the right insurance in place.
Underinsurance, which occurs when coverage does not fully meet a policyholder's needs, can create significant challenges for businesses. No matter the size of the claim, if the insurer finds the sum insured is too low or the indemnity period too short, the business could find itself liable for at least some of the costs.
Having to fund these additional costs can be difficult, particularly at a time when business operations are temporarily paused due to a loss. In severe instances, this could impact the businesses’ ability to continue operations.
Underinsurance poses risks for all businesses, but the consequences can hit some sectors harder than others. The scale of a potential loss means that businesses in the property and construction sectors may face difficulties in recovery without adequate coverage. Similarly, without the financial reserves of their larger peers, an SME can find it difficult to get back on its feet if it’s found to be underinsured when it suffers a loss.
A common issue
Whether it’s down to a simple misunderstanding around the amount of insurance required, or the business owner unwittingly reduces cover to cut costs, underinsurance is a prevalent issue
Underinsurance is said to have fallen to its lowest level for at least 6 years, but when talking about property, insurance valuation specialists RebuildCostAssessment found that 76% of building in the UK are underinsured. Not only that, for those that don’t have adequate insurance, they’re only covered for an average of 63% of their total rebuild value. Additionally, a 2025 Allianz SME survey revealed that only 52% of owners know the rebuild value of their business’ property, 59% of which had a professionally qualified valuation, leaving a large percentage unaware of the true cost of rebuild.
Although the level of cover is the worst on record, there are some positives in its findings. The percentage of UK buildings underinsured is falling – from a high of 83% in 2022 – but, with less than a quarter of properties adequately insured, more needs to be done to ensure landlords and property owners are financially protected in the event of a loss.
Undercover causes
Given how widespread underinsurance is, there are several reasons why a property business could find itself with too little cover.
Sum insured slippage
Setting the sum insured on a property is notoriously tricky. The British obsession with property prices means it’s common to plump for the purchase price or the valuation used for mortgage purposes.
But, as the figures from RebuildCostAssessment demonstrate, this can be markedly below the actual cost of having the building professionally rebuilt. Setting the sum insured at its average of 63% of the rebuild value, would mean a shortfall of £370,000 on a £1 million property claim.
Indemnity period optimism
Another common error is underestimating how long it will take to get a property back on the rental market following a catastrophic loss, such as a fire or flood. Rebuilding or reinstating a property takes time, especially where it’s a more unusual build or planning permission is required. Even a standard build can take longer than expected if there are issues sourcing materials and labour.
Claims cost inflation
Failing to factor in the rising cost of materials and labour can also lead to huge gaps between sums insured and claims costs. This has been a particular challenge over the last few years due to above inflation rises in costs in the construction sector.
Although much of the heat has come out of the market now, the latest Building Cost Information Service (BCIS) forecast predicts a 17% increase in building costs over the next five years. Labour costs, it says, are the main driver behind this as construction firms face increases to national insurance contributions and the national living wage.
Supply chain stretch
It’s not just the rising cost of materials that can lead to underinsurance: supply chains are stretching as a result of issues such as geopolitical pressures, additional compliance and trade wars.
Whatever the reason, it means it can take longer to repair or rebuild a property. This can have ramifications for a business interruption claim but will also drive up the total cost of the claim.
Going direct
For many property owners, buying insurance is an annual chore with price being the key determinant. Although they will probably flag up any changes to their portfolio, without advice, it’s unlikely they’ll give a second thought to a shift in the price of timber or how long it takes to get a team of builders together.
But going direct to save a few pennies is a false economy if it leaves a property owner seriously exposed when it comes to cove. An experienced broker can help property owners ensure they have the correct cover in place.
Indexing magnification
Taking out cover that includes indexation can help sums insured keep pace with inflation but it can also result in a false sense of security. While the cover will increase each year, this could be well out of line with the cost of the underlying materials and labour.
Alongside the traditional risks, there are emerging risks that could make it more difficult for a business to avoid the underinsurance trap such as;
- Climate change could lead to increased risk of flood and fire but it could affect the production and supply of building materials too, pushing up costs.
- Geopolitical issues could also put further pressure on supply chains, with conflict closing markets and making materials more expensive. It can add delay and cost to the supply chains too, as was seen in 2023 when the Houthi attacks in the Red Sea forced ships to take a longer route around Africa.
- Even US President Trump’s trade tariffs could affect insurance claims. As firms are forced to pay more to export their goods to the US, some of these additional costs are likely to be passed on to customers, including insurers.
Risks and financial implications
Underinsurance is an important issue that can lead to consequences beyond reduced claims settlement. Although an insured might believe they have sufficient cover to fix any of the smaller claims they have, underinsurance could mean they’re seriously out of pocket.
Some insurers may apply the average clause. With this, the insurer reduces the settlement by the same percentage as the level of underinsurance.
Example: A landlord takes out a buildings policy for £600,000 on a property that will cost £1 million to rebuild. If the roof is damaged in a storm and needs £50,000 of repairs, the insurer might only pay 60% of the claim – leaving the landlord to find £20,000.
Selecting the wrong indemnity period can hurt too. Go too low and the property owner will miss out on income while the property is being repaired or rebuilt.
As well as the financial risks associated with underinsurance, there are legal implications too. Under the Insurance Act 2015, insureds have a duty to make a fair presentation of risk. Where the insurer suspects they have deliberately understated the sums insured, it’s within its rights to void the policy altogether. This would leave the insured to pick up the full cost of any claim.
Preventative measures
Underinsurance may feel unavoidable without a daily reckoning of the cost of materials and supply chain issues. But there are ways to ensure sums insured and indemnity periods stay aligned with claims costs:
Professional valuations
Starting with accurate sums insured makes it a lot easier to avoid underinsurance. A reinstatement cost valuation by a RICS (Royal Institution of Chartered Surveyors) qualified valuer will give a property owner the peace of mind they have the correct level of cover. They will also be able to provide guidance on any trends in rebuild costs that might affect a property owner’s portfolio.
This exercise can be repeated, either in person or through a desktop valuation, every few years, depending on the type of property, to keep sums insured accurate.
Regular reviews
Regular reviews are important: without one, even the smallest degree of underinsurance can quickly become a gaping chasm. Looking at sums insured every year and factoring in any changes to the cost of materials and labour as well as any issues that might be affecting supply and the length of time it takes to rebuild can help avoid underinsurance.
To help maintain accurate sums insured, commercial property policies often include a provision, Day One Uplift, which increases the building’s declared value by a set percentage to take inflation during the policy term into account.
Take advice
Support and guidance from an insurance broker is also key to ensuring appropriate cover and indemnity periods are in place. They will understand the business’s specific needs and risks and be able to provide advice on insurance and risk management.
Underinsurance and the role of the insurance sector
Taking out the wrong level of insurance can be a costly mistake for a property owner, potentially putting their business on the line in the event of a loss. Brokers and insurers have a key role in ensuring they avoid this mistake, helping these businesses understand the risks associated with underinsurance and the value of having the right cover in place.
