Are Property Premiums Depressed by Underinsurance?
Speak to any property underwriter and the conversation quickly turns to how “soft” the market is and how low the rates are. But one thing rarely mentioned is the amount of premium that isn’t paid due to incorrect valuations on property policies. Around 80% of commercial properties are underinsured in the UK.1 At Gen Re, we have noticed that underinsurance is a global problem, and it isn’t limited to buildings. Claims are bringing to light the inadequate sums insured for Machinery, Stock and Business Interruption/Extra Expense in addition to Buildings.
The reasons for underinsurance vary:
- A failure to consider the costs of car parks, walls, roads and other items included in the definition of buildings within the sum insured
- When establishing a buildings sum insured, not making an allowance for professional fees, debris removal, public authority requirements and taxes
- Insureds using a figure for Machinery taken from their GAAP Accounts (This figure is subject to depreciation and will not cover the replacement cost.)
- Stock being valued at cost price when the policy is on a selling price basis
- Confusion over the term Gross Profit (GAAP Accounting Gross Profit is different from the definition in insurance policies and leads to underinsurance. Insurers should consider replacing the term Gross Profit with “Insurable Gross Profit”. Insureds may then realize that Insurable Gross Profit significantly differs from GAAP Gross Profit.)
- Neglecting to insure import products and components, commitments that cannot be immediately terminated (These costs are more “fixed” than “variable” and need to be insured.)
- Insureds and their brokers setting low sums insured in order to achieve a lower premium
While those are some of the more common reasons for underinsurance that highlight the symptoms, they are not the cause. Setting sums insured is a complex issue, with insureds and their advisors not being equipped with the expertise to come to terms with many of the difficulties. Insurers need to change their approach to the setting of sums insured and to become more actively involved. For too long the setting of sums insured has been left to the insured and their advisors. There is an opportunity here for insurers.
We estimate that the resulting underinsurance means that insurers and reinsurers are potentially missing out on 25% to 33% additional premium. We recommend that insurers provide expertise in the setting of sums insured, either in-house or through a panel of nominated experts. Would underwriters still feel rates were too low if they were collecting the additional 25% to 33% of premium on which they are currently missing out?
Helping insureds establish values also provides a means of differentiation from competitors. Think of the higher claim satisfaction that will come after a loss. Not only is the insurer more likely to write business profitably, it will provide a more stable product offering over time with a differentiated value proposition. That is not a depressing thought.
- Building Cost Information Service Report 2012