The importance of avoiding unintentional underinsurance on Household, Property Owners and Buildings insurance policies

March 2021

Despite being one of the most common problems encountered by policyholders in the UK, many remain unaware of the perils of underinsurance.

In a 2012 survey undertaken by the Building Cost Information Service - part of the Royal Institution of Chartered Surveyors - it was estimated that 80% of all commercial properties were underinsured, which could then leave policyholders in a precarious position if an incident were to occur.

Underinsurance is referred to as the ‘Condition of Average’ in most policy wordings, and it applies where the value insured by you is less than the actual cost associated with rebuilding or replacing the section insured. In this scenario, insurer liability for any loss would be proportionately reduced by the amount of underinsurance between the two values. The underinsurance clause applies in the majority of material damage policies where buildings, contents or machinery are insured.

Our partners at Rebuild Cost Assessment have produced this straightforward video explaining the application of the Condition of Average:

Let’s consider buildings insurance: a common misconception is that the market value is the same as - or strongly correlates to - the reinstatement declared value (the rebuild cost) of a building. In fact, the market value takes into account the value of the land upon which the property is built, but it is wholly unconnected to the building’s reinstatement declared value. The latter is calculated according to the cost of rebuilding the property to its former state, including the costs of any debris removal and professional fees, with no consideration of the value of the land itself.

If a building is insured for £400,000 but the true cost of rebuilding the property is £500,000, the property is underinsured - but what does this mean in the event of a claim?

If a small fire were to occur at this property causing £25,000 worth of damage to the building, insurers would apply the Condition of Average on the basis of the property being underinsured. In this scenario, the policyholder has only insured 80% of the true cost of rebuilding the property and the Condition of Average would then be applied, meaning that the insurer would only be obliged to pay out 80% of the claim’s value.

In this example, the insurer would pay out £20,000, meaning that the remaining £5,000 of fire damage would not be covered.

To avoid unintentional underinsurance, there are a number of steps that you can take. Regular reviews of the sums insured should be carried out; at the very least, the building reinstatement declared value should be index-linked annually at renewal to ensure the figures remain in line with inflation.

There are a number of rebuild calculators which can give general guidance on a property’s rebuild cost such as the tool offered by the Association of British Insurers, however an Insurance Reinstatement Survey undertaken by a RICS registered surveyor will always generate the most accurate figure.

Some insurers agree to waive the Condition of Average for three years after an authenticated Insurance Reinstatement Survey has been undertaken by a RICS registered specialist, provided that the surveyor’s reinstatement recommendation is followed and index-linked annually thereafter.

However, if the Condition of Average is a significant concern and an Insurance Reinstatement Survey by a RICS approved surveyor is not affordable, a limited number of insurers are now offering ‘Average Free’ policies, whereby the Condition of Average is entirely removed from the policy. Instead, these select insurers rely on the Insurance Act 2015, which imposes a duty on the policyholder to provide a “fair presentation of the risk” to the insurer. So long as the policyholder has provided their best estimate of the true rebuild cost, this duty should be deemed to be satisfied.

If you would like to find out more about underinsurance and how it can be avoided, please contact us here and one of our team will be in touch.