What is commercial property underinsurance?
Underinsurance occurs when the sum insured is lower than the true cost of rebuilding a property.
Many owners assume insurance should be based on a building's market value. In reality, insurers are generally concerned with its rebuilding value, which is the cost of reconstructing the premises following a major loss.
This can include:
- Demolition and site clearance
- Construction materials and labour
- Professional fees
- Architects and surveyors
- Planning and compliance costs
- Inflation-related increases in rebuilding expenditure.
If these factors are underestimated, there may be a shortfall between the cover in place and the amount required to recover from a loss.
Why underinsurance is becoming more common
Several factors have made underinsurance a growing issue for commercial property owners.
Rising rebuild costs
Although inflation has eased from the peaks seen in recent years, rebuilding costs remain significantly higher than many owners expect.
Labour shortages, supply chain disruption and increases in material prices have all contributed to higher rebuilding values. A building that was valued accurately several years ago may no longer be insured for an adequate amount today.
For those who have relied solely on index-linked increases at renewal, there is a risk that the sums insured no longer align with the true cost of reconstruction.
Changes to buildings
Many commercial premises have evolved over time. A warehouse may have been extended. An office building may have undergone refurbishment. A retail unit may have been fitted out to a higher specification. These improvements can increase rebuilding values, particularly if they have not been reflected in the insurance programme.
It is often these gradual changes, rather than a single major project, that lead to underinsurance.
Evolving regulatory requirements
Rebuilding after a major loss is not always a straightforward exercise in replacing what was there before.
Building regulations and safety requirements continue to develop, and reconstruction may need to comply with current standards rather than those that applied when the building was originally constructed.
For owners, this can increase both the expense and complexity of rebuilding, making accurate valuations more important than ever.
Market value and rebuild cost are not the same thing
One of the most common causes of underinsurance is confusion between a building's market value and its rebuild cost.
Market value reflects what a property may be worth if sold. Rebuild cost reflects what it would cost to reconstruct that building following a total loss.
The two figures can be very different.
Location, demand and investment yields can significantly influence market value, but they have little bearing on the cost of rebuilding the structure itself. Equally, professional fees, demolition costs and compliance requirements may increase reconstruction costs without necessarily affecting market value.
Using one figure as a substitute for the other can create a false sense of security.
The average clause: where underinsurance becomes expensive
One of the most significant consequences of underinsurance is the application of the average clause.
Where a building is insured for less than its full rebuilding value, insurers may reduce claim payments in proportion to the level of underinsurance.
According to guidance from Allianz Insurance, businesses can find themselves responsible for part of a claim where the sum insured does not accurately represent the value at risk.
For example, if a building should be insured for £2 million but is insured for only £1.5 million, it is effectively insured for 75% of its value.
If a £400,000 claim arises, the insurer may pay only 75% of that amount, leaving the policyholder to fund the remaining balance.
This often comes as a surprise because many owners assume underinsurance only becomes an issue following a total loss. In reality, the average clause can apply to partial claims as well, meaning relatively modest losses may still be affected if the sum insured is inadequate.
Business interruption is often overlooked
Physical damage is only one part of the financial impact following a major incident.
A serious fire, flood or escape of water can leave premises unusable for months. Rental income may be lost, tenants may need to relocate, and normal business activity can be disrupted while repairs are carried out.
Rebuilding projects frequently take longer than expected, particularly where specialist contractors, planning approvals or supply chain delays are involved. As a result, an indemnity period that appeared sufficient when cover was arranged may no longer be adequate following a significant loss.
Signs your property could be underinsured
It may be worth reviewing your insurance arrangements if:
- The building has not been professionally valued for several years
- Significant refurbishment or extension works have been completed
- Construction costs have increased since cover was arranged
- The property has been acquired recently
- Sums insured have simply been rolled forward at renewal
- Occupancy or usage has changed
- Your portfolio has expanded.
None of these automatically indicates underinsurance, but they are sensible prompts to check whether your cover remains aligned with current rebuilding costs.
Professional rebuild cost assessments
Regular reviews are important, but they are most effective when based on an accurate understanding of a property's rebuild value.
A professional rebuild cost assessment can help establish the cost of reconstructing a building following a major loss, taking into account factors such as demolition, professional fees and current construction costs. For property owners, this can provide greater confidence that sums insured reflect the true value at risk.
Don't wait until a claim reveals the problem
Commercial property underinsurance rarely stems from a single decision. More often, it develops gradually as costs rise, buildings evolve and historic valuations become outdated.
The difficulty is that these gaps often remain hidden until a claim is made. At that point, the financial consequences can be significant, particularly where the average clause applies.
Regular valuations and periodic reviews can help ensure sums insured remain accurate and that cover keeps pace with changing rebuilding costs and regulatory requirements.
Rebuild cost assessment services
Whether you own a single property or manage a larger portfolio, ensuring your buildings are insured for the correct rebuild value can help reduce the risk of underinsurance.
Clear works with RebuildCostASSESSMENT.com to help property owners obtain professional rebuild cost assessments that support accurate sums insured and informed insurance decisions.
To learn more, visit our Rebuild Cost Assessment Services page.
