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Underinsurance – let's keep talking

Published: 19/11/15

You could be excused for thinking we really are going on about this a bit too much. However, we know that underinsurance continues to be an issue for SMEs and so we must keep the discussion going until the right levels of cover are always in place.

If you are underinsured and you experience some kind of loss at your business, the chances are that any claim settlement will not reach your expectations. And if your insurance underperforms it's highly likely that at best, you won't be happy, and at worst, who knows? As your insurance broker, this is what we at Flint want to avoid.

Typically it is you, our client who specifies your own sums insured and whilst we are not expected to calculate figures on your behalf it is our professional duty to provide adequate explanations. We need to ensure that you fully understand the meaning of key terms, such as insurable gross profit and how it differs from the accounting definition of gross profit. Insurable gross profit is a more complex calculation that takes into account opening and closing stock, work in progress and uninsured working expenses.

1 Total Cost of Risk

Total Cost of Risk (TCOR) is not simply insurance premiums alone, but is calculated using the business's insurance premiums, direct costs, indirect costs and risk management expenses. It is only when you break down and understand all of these costs that you can implement strategies to reduce them.

TCOR is crucial when examining the trade-off between self-insurance, insurance and risk management investment.

2. Regular Valuations

(market value Vs cost of reinstatement)

According to recent Insurance Times research, 63% of insurance brokers questioned cite failure to carry out regular valuations/assessments as the main cause of underinsurance.

For stock valuations it's important to determine the maximum value of stock at all the different stages and times of year of a business's operation. This might also need to include the market costs of raw material, freight, unloading and storage costs.

Any stock assessment also needs to take seasonal variations into account – the sums insured should reflect the maximum possible loss.

Plant and machinery is normally valued on a reinstatement basis. Reinstatement covers the cost of repair, without deductions for wear and tear and other forms of depreciation or cost of replacement, meaning with a new item of the same, i.e., new for old.

Sums insured on a reinstatement basis should include the full cost of completely replacing an item of plant or machinery with a new item of a similar type, capacity and utility. In addition to the purchase cost, this sum should include factors such as freight and installation costs.

Buildings are another area for important consideration being subject to a constantly changing landscape that can affect their valuation. Availability of materials, fluctuating labour costs and planning regulations, particularly those that stipulate a lower environmental impact, all have potential to significantly alter the final reinstatement cost.

Regular professional valuations are the best way to ensure adequate sums insured. The cost of engaging a valuation specialist will be minimal compared to the potential shortfall in claims settlement, should you suffer a major loss for which you are underinsured.

3. Pay attention to Business Interruption

Business Interruption (BI) is a particular problem area for underinsurance. There can be a significant difference between the insurable gross profit and an accountant's gross profit calculation. And it is these major differences that are covered within BI.

Similarly indemnity periods are commonly found to be inadequate, where customers regularly choose a 12-month maximum indemnity period believing it to be long enough, but in reality it often isn't.

4. Business continuity planning

Insurance is in place to indemnify you against any losses incurred, but an effective business continuity plan can make a great difference to the size of those losses, including the ability to finish trading and make a full recovery.

Planning for major loss scenarios can also help prevent underinsurance. By having plans in place to minimise loss and recover more quickly, you can reduce the risk of exceeding sums insured and indemnity periods.

Flint is able to provide essential guidance on risk management and business continuity planning; speak to your commercial account handler for access to these services.

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