Underinsurance is the most important – and most disappointing – rule in property insurance: if the sum insured is lower than the real value of the assets, the insurer can settle the claim proportionally. This is a fact of how the product works, not scaremongering – and, most importantly, a few good habits can rule it out almost entirely.
- Underinsurance = the sum insured is lower than the asset group’s value under the valuation method chosen in the policy – for a policy written at reinstatement value, today’s replacement (rebuilding, new-for-old) cost; for one written at actual (depreciated) value, the value reduced by depreciation.
- The result is the average (pro-rata) rule: for assets insured at half their value, only half of a partial claim may be paid.
- Three habits protect you: real values when taking out cover, accepting indexation, and an annual review – with a mid-term increase for major changes.
How does the sum insured slip?
Rarely on purpose – typically quietly. The policy was set up five years ago; material and labour costs have risen since; the machinery fleet grew by two new machines that were never added; stock levels doubled after a good year. The figure fixed in the policy doesn’t track reality on its own – and every year that passes without a look widens the gap. A typical source of error is also setting the building’s value from the market price or the book value: neither reflects the cost of rebuilding – details here.
What happens at claim time? The rule, in short
The general principle in property insurance: if the sum insured is lower than the real value at the time of the claim, the insurer typically settles the claim in the same proportion as the sum insured relates to the real value. As a principle, without figures: if the warehouse stock is insured at 60% of its real value, even a partial fire claim may only pay out 60% of the loss – the rest falls on the company. So underinsurance doesn’t only hurt on a total loss: it cuts into small and medium claims too.
The exact rules – including any tolerance bands – are set by the given insurer’s terms; this is also worth factoring in when comparing offers.
Why isn’t this a trick by the insurer?
Because the premium is proportional to the sum insured: insuring for a lower amount means paying a lower premium – you’ve effectively kept part of the risk yourself. The pro-rata rule simply makes that visible, just at the worst possible moment. The system is logical, but it times itself mercilessly: it can go unnoticed for years and typically only surfaces at the big claim. That’s why I treat it as a fact, not a bogeyman – it’s not something to fear, but something to rule out through maintenance.
The fix: three habits
First: start from real values when taking out cover – rebuilding cost for the building, a fresh inventory for machinery, real levels for stock. The site inventory template gives you a framework for this. Second: don’t reject the anniversary indexation out of reflex – tracking value isn’t a premium-hiking trick, it’s maintaining the sum insured. Third: a fifteen-minute review every year, and for major changes – a new machine, a jump in stock, an expansion – a mid-term notification.
With these three habits in place, the pro-rata rule is unlikely to touch you in practice – the policy will cover exactly what the company pays for.
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