Underinsurance

Underinsurance: 75% of US businesses are Currently Underinsured

In times of economic pressure it is hard to convince businesses of the need to take out a full portfolio of insurance, especially when they have not experienced a previous claim or understand the devastating effects of underinsurance.

5 Underinsurance Mistakes to Avoid as a Startup

It is thought that up to as many as 80% of UK businesses and 75% of US businesses are currently underinsured which can result in a huge aftermath of losses, should an incident occur that requires repair or rebuild of property or interruption of business. With such a large percentage of businesses found to be underinsured it is important to understand how to avoid the most common mistakes that result in up to 40% of businesses not re-opening following disaster.

Following the recession unfortunately many businesses, specifically small startups, experienced the false economy of underinsuring their business in a bid to save money. In times of economic pressure it is hard to convince businesses of the need to take out a full portfolio of insurance, especially when they have not experienced a previous claim or understand the devastating effects of underinsurance.

Reasons for underinsurance

Underinsurance is not always intentional. It has also been found that many others who are more savvy to the issues have simply underinsured due to misunderstanding insurance requirements or error in calculation rather than a bid to intentionally attempt cost-savings. In most cases this error comes in the form of a miscalculation of ‘market’ versus ‘total value’ of property.

Another common underestimation is the period of indemnity required should business activity be interrupted. It has been found that as many as 40% of businesses are also underinsured for business interruption and unless a business is re-valued regularly there is likely to be a sizeable shortfall in re-build costs which will be entirely in the hands of the underinsured to meet financially, clearly risking the overall survival of many businesses.

Some of the most common underinsurance mistakes to watch out for:

  1. Calculate re-build value and include surroundings:

To avoid underinsurance in this area you need to make sure you are insuring against the re-build value not the market value of the business. Often the true re-build value can be much higher than the market value, in some cases even double the amount. A rebuild cost should not just focus on the main structure of the building but also include any other elements such as surrounding roads, fencing, and car parks.

You need to also ensure that you include costs for demolishing the entire remaining structure, site clearance, planning, architects, surveyors, etc before the rebuild even starts in addition to a realistic timescale on the indemnity period. All too often the true charges for labour in such an event are also wildly underestimated.

  1. Machinery and Plant can be subject to overseas delays and currency fluctuations:

The lead times for bespoke machinery can often be much longer than anticipated and often when coming from overseas you need to ensure that you factor in currency fluctuations. It is important to maintain an up-to-date register of all your machinery, plant and contents to make sure that you are fully covered. A good understanding of the type of insurance you have in place is also needed. For example, reinstatement cover will replace old for new, whereas indemnity cover will only pay out the value at the time of the loss – which may in some cases be appropriate if you are intending to replace second-hand.

  1. Be realistic when insuring for business Interruption

Often a standard business interruption indemnity period is underestimated at 12 months and is not a true reflection of the time needed to truly recover trading following such a loss. For a fully reasoned view you should also take into account business growth trends, a business’ insurance policy needs to grow with the business. It is important to consider if the business is growing, have new braches been opened or has a competitor recently closed down? A ‘Declaration Linked Basis’ can allow an estimate of the likely gross profit to be given at the renewal which can be confirmed once the actual figures are available.

  1. Use the insurance industries definition of gross profit

In addition to this there is the unfortunate reality that the accounting definition of gross profit and insurance definition are inconsistent and cause much confusion. Accountants show gross profit after the deduction of purchases and would strip out staff and utility costs. For insurance purposes gross profit should be considered including such purchases to avoid any unpleasant surprises.

  1. Don’t forget to add on any new purchases

A ‘capital additions’ clause will allow for around 10% of the overall insured sum to be added for additional purchases of equipment or office locations since the insurance was taken out. However, if any purchases exceed this amount you should notify your broker to add these to the policy.

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