Underinsurance: A Silent Threat to Your Business That You Can’t Afford to Ignore.
In the dynamic landscape of New Zealand's SME and commercial sectors, safeguarding your business assets through insurance is paramount. Yet, one of the most critical decisions - how much to insure your assets for - is often overlooked or underestimated, leading to the pervasive issue of underinsurance.
Aon recently analysed 13,000 policies in New Zealand, revealing that up to 43% could potentially be underinsured, highlighting the problem may be much closer to your business than you might realise.*
Let's delve into the true consequences of underinsurance, how it can impact a claim, and steps you can take to prevent it.
The hidden danger of underinsurance: Is your business at risk?
Underinsurance occurs when business assets are insured for a value that is less than what it would cost to replace them with something of similar make, model, or capacity.
For example, if equipment is insured for $100,000, but the cost to replace the equipment after a loss is $200,000, the equipment is underinsured and the discrepancy can lead to significant financial strain.
How underinsurance happens
Underinsurance can happen for several reasons:
1. Inflation: Over time, the cost of materials and labour increases, leading to a gap between the insured value and the actual replacement cost. In New Zealand, inflation rates have seen significant fluctuations—while recent figures indicate a more moderate increase of approximately 2% to 3% over the past year, this marks a decline from the post-COVID highs when inflation surged to levels not seen in decades**. This volatility can significantly affect the cost of rebuilding or replacing assets, making it essential to regularly update insurance valuations to ensure adequate coverage.
2. Underestimating values: Accurate assessment of asset replacement values is crucial. Insufficient coverage often stems from not fully understanding the true replacement value.
3. Increased premiums: As insurers face higher costs, they may increase premiums to maintain profitability. Higher premiums can lead to policyholders opting for lower coverage limits or higher deductibles to keep their insurance affordable, which can result in underinsurance.
4. Incomplete valuation: Failing to include all necessary assets in the valuation process can result in underinsurance. This includes overlooking site improvements, specialised equipment, fit-outs or, when asset values are missed completely.
For example, a retail store owner might focus solely on the building value and overlook the value of their storefront, signage, awnings, or customer access areas. If a storm damages these overlooked assets, even with adequate building coverage, the insurance recovery may fail to cover the repairs. This oversight can lead to reduced customer traffic and lost sales, highlighting the importance of comprehensive asset valuations.
Peter Erceg, Director Valuation Services for Aon in New Zealand, describes how these factors can lead businesses to make decisions that prioritise immediate affordability over comprehensive coverage.
“Policyholders may underestimate the value of their assets or the potential cost of claims, leading to insufficient coverage. Additionally, the complexity of adjusting insurance values to keep pace with economic changes can be daunting, resulting in incorrect assessments of insurance needs.”
The true cost of underinsurance
In the event of a claim or total loss, being underinsured often means having to contribute to the cost of repairs or replacements out of your own pocket.
Many business owners misunderstand how underinsurance works, thinking they can downgrade or purchase less equipment if there is a claim. However, this affects the maximum amount an insurer is required to pay, potentially leading to compromises in material quality or design features during rebuilding.
Know the difference between a bank vs. insurance valuation
It's crucial to understand that a bank valuation, which often reflects the market value of an asset, is not suitable for insurance purposes. This is because it won’t reflect the true cost of replacement or rebuilding. An insurance valuation, on the other hand, considers the full replacement cost, ensuring that you are adequately covered in the event of a loss.
Steps to protect your business from underinsurance
Preventing underinsurance requires diligence when purchasing or renewing insurance policies. Calculate the cost of replacing or rebuilding assets new for old, rather than relying on purchase amounts.
“To mitigate underinsurance, it is important for policyholders to regularly review and update their insurance coverage to reflect current values and risks. Implement an auditable process with a professional insurance valuation service for annual reviews as they will provide clear guidance and recommendations on how to assess and adjust coverage accurately. Regularly review your sum insured, especially when acquiring new equipment, upgrading, or renovating.” says Erceg.
Talk to Aon Valuation Services today to ensure your assets are accurately valued for robust business protection and resilience.
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