5 Trends driving business underinsurance

Avoiding the financial ramifications of not having sufficient cover for a claim. Many businesses are faced with an increasingly volatile political and socio-economic climate.

Not only are businesses having to manage a whirlwind of change and disruption in their business models, such as technology, changing consumer behaviour, socio-demographic shifts, climate change and the pandemic, but they’re also being confronted by a heavily constrained economy and rising inflation. Clayton Ellary, from Aon South Africa’s Commercial Risk Solutions, explains that as pressures mount, more and more cases of underinsurance are being recorded. “Underinsurance is when insurance cover in terms of sum insured is not sufficient to cover the full cost of a potential claim. It can apply to a property, plant and machinery, business interruption and even exposures like cyber liability and Directors and Officers cover. In fact, any area of insurance can be impacted by underinsurance with potentially severe consequences for the balance sheet and the ability of the business to recover from an uninsured or underinsured loss,” explains Clayton.

Using a property claim as an example, Clayton explains how underinsurance occurs:

Following a loss, your insurer will calculate the replacement value for which you should have insured your buildings or contents. If your sum insured is less than the actual replacement value, your insurer will pay a proportion of your claim.

Example:

Claim: R200 000 Sum Insured: R1 000 000 Replacement value: R2 000 000

The underinsurance calculation is calculated as follows:

Sum Insured / Correct Replacement Value X Value of Claim R1 000 000 / R2 000 000 X R 200 000 Claim settlement = R100 000 “As illustrated, the implications of under-insuring your assets can be severe as you run the risk of being inadequately indemnified in the event of a loss due to the application of what is termed the ‘Average formula’,” Clayton warns.

Aon highlights 5 factors driving the business underinsurance trend, including:

• The steep rise in costs of labour and materials, exacerbated by exchange rate and commodity volatility is making repairs and replacement of machinery, equipment and property far more expensive. Property values are also on the rise, adding extra pressure in this space. • Business interruption indemnity periods are often not sufficient for the true scale of an insured event. Claims costs are also on the rise, notably in areas such as Directors & Officers Insurance (D&O) and cyber liability - all leading to insurance limits that need to be increased. • If an insured elects an indemnity period of longer than 12 months, then the Gross Profit sum insured should reflect that period. In addition, if the indemnity period is 24 months, the trended Gross Profit should reflect that period. • If an insured selects an indemnity period of less than 12 months, the Gross Profit sum insured should reflect 12 months – this is in accordance with standard policy terms and conditions. • Increased insurance pricing, reduced reinsurance capacity and restrictions in the scope of cover have created significant challenges. It’s one reason why we have seen a hike in insurance pricing – by as much as 50% or more in some instances and lines – as well as restrictions in cover and even markets withdrawing from certain industry sectors as