What happens if I under insure?
In Australia, under many policies of insurance if you under insure you are penalised when it comes to a claim. Even in partial losses you may be deemed to be carrying some of the risk yourself and the Insurer will ask you to bear a portion of the claim yourself.
Please note that this does not apply to policies issued in the New Zealand market where co-insurance or average have been removed. Nonetheless, a policyholder may still run out of sum insured in the event of a major loss.
Turning back to Australia, the penalty for under insurance, even with partial losses is the case with most business interruption policies. Under an ISR and one or two business packs, it is 100% Average. That means there is absolutely no tolerance for getting it wrong. If you are under-insured by 5% you only be paid 95% of your loss. Under many business packs there is a 20% tolerance built in Only if you are less than 80% insured will you be asked to contribute to the loss, and even then a 20% softening will be incorporated in the calculation. One or two policies are not subject to Average, or Co-insurance as it is sometimes called. Interruption Underwriting Agencies Instant Profits cover is an example.
Please review what is covered under the policy you wish to use with your insurance broker or adviser. Some explanation is provided with our business interruption calculators. Business Interruption policies have one of the worst if not the very highest incidence of under insurance of all the classes of general insurance. It is estimated that over 70% of policies have some form of under insurance.
To show the impact of under insurance we include the following example. The formula on a policy with 80% co-insurance is:
If we insured for $500,000 and the value at risk was say $1,000,000 with a loss of $200,000 the claim would be adjusted as follows.
When you consider the premium saving on $500,000 was somewhere in the region of $1,250 depending on the occupation of the business the loss of 60 times ($75,000 - 1,250) that figure on this moderate loss shows the complete folly of risking under insurance. You are really risking the very survival of your business. When you consider that one in 500 businesses suffer a loss every year, a prudent business person would never risk it.
Under insuring the Insurable Gross Profit is just one form of under insurance. Others are not having a sufficient Indemnity Period, see How Long Should I Insure For, wages cover, claims preparation fees or Additional Increased Cost of Working cover. In summary then, Business Interruption Insurance is not a first loss cover. If you under declare your sum insured (sometimes called Declared Values) then you are deemed to be your own insurer for the proportion of any loss no matter how small or large. In reality the cost of insurance is not high, particularly when you consider the level of protection it can bring in the event of even a short disruption. The cost is tax deductible and unless your business has significant cash resources or you have the ability and are prepared to fund the recovery program yourself it is a product that we at Policy Coach Pty Ltd strongly recommend.