Underinsurance

Underinsurance happens when your sum insured or coverage limits are too low to fully cover a loss. You end up paying the shortfall out of your own pocket.

It’s one of the most common and costly mistakes in Australian insurance. You think you’re covered, but when a claim happens, the numbers don’t add up.

Why It Matters

• If you’re underinsured, your payout will be less than what it costs to repair, rebuild, or replace.
• Some policies include an average clause (also called co-insurance). If your sum insured is less than the actual value, the insurer can reduce your payout proportionally, even on partial claims.
• Building costs, equipment values, and stock levels change over time. If your cover hasn’t kept pace, you could be underinsured without realising it.
• Underinsurance affects business insurance, property insurance, motor insurance, and more.

Show Transcript

Is your sum insured when it comes to insurance costing you? The sum insured amount is the maximum amount that your insurer will pay for a claim. It's set based on your business revenue, assets, and risks. Underestimating it could leave you uninsured in a crisis. However, overestimating might mean that you're paying more for premiums than you need to. It often covers property, equipment, stock, or business interruption. Insurers, they might use financial data or valuations to be able to determine the amount. In some cases, outdated sums could lead to reduced or rejected claims. It is critical for rebuilding after events like fire or theft. Regularly updating it can reflect business growth or change. Just keep in mind that sometimes policies are set to autorenew. So, make sure that you know when you are renewing, you always have the most accurate and up-to-date sums in there. Misjudging asset value could impact your coverage accuracy. So, keep in mind that it's not just about replacement costs, but it's about business continuity. And I always say this, I'll stress it again. Make sure that you speak with your insurer or your insurance broker annually to do your review and make sure the amounts on there are accurate so you're covered in the event of a claim and not overinsured or underinsured.

How the Average Clause Works

Say your commercial property is worth $1 million to rebuild, but you only insured it for $500,000. That means you’re insured for 50% of the actual value.

If you make a claim for $200,000 in damage, the insurer may only pay 50% of the claim ($100,000) because you were only insured for 50% of the total value. You’d have to cover the other $100,000 yourself.

This applies even though the claim was well under your sum insured. That’s how average clauses work, and it catches a lot of people off guard.

Common Causes

• Not updating your sum insured after renovations, additions, or equipment purchases.
• Using outdated valuations for your building or contents.
• Underestimating the cost of rebuilding, which includes demolition, council fees, and compliance with current building codes.
• Setting your sum insured too low to reduce your premium.
• Forgetting to include items like landscaping, fencing, driveways, and fit-out costs.

Simple Examples

• A warehouse owner insures their building for $2 million, but the actual rebuild cost is $3.5 million due to increased construction costs. After a fire, they receive a reduced payout.
• A retailer insures stock for $100,000 but their peak stock holding is $250,000. A theft during peak season leaves them significantly short.
• A homeowner insures their contents for $50,000 but the replacement value is $120,000. After a burglary, the payout doesn’t come close to replacing everything.

Common Mistakes or Misunderstandings

• Thinking “she’ll be right”. Underinsurance is a real problem in Australia. The Insurance Council of Australia has repeatedly highlighted it as a major issue.
• Confusing sum insured with market value. Your sum insured should reflect the cost to rebuild or replace, not the market or sale price of the property.
• Not getting regular valuations. Building costs can change significantly year on year. A valuation every 3 to 5 years helps keep your sum insured realistic.
• Deliberately underinsuring to save on premiums. The premium savings are small compared to the risk of a reduced payout when you claim.

When to Speak to a Broker

If you haven’t reviewed your sum insured in the last couple of years, aren’t sure whether your building valuation is current, or want a second opinion on your coverage levels, a broker can help you get the numbers right.

Need help?

If you want to check whether you’re properly insured or need help getting an up-to-date valuation, reach out to Tank Insurance and we’ll review your cover.

Related Terms

• Principle of Indemnity - Insurance aims to put you back where you were before the loss, but underinsurance means the payout falls short of that goal.
• Insurance Premium - Your sum insured directly affects your premium. Setting it too low saves a little on premium but risks a lot at claim time.
• Total Loss - Underinsurance is especially painful in a total loss scenario where the entire asset needs replacing.