Underinsurance: the hidden risk that could cost your business

Did you know that three out of four small businesses are underinsured, leaving them open to expensive claims that can’t pay out? A recent industry report reveals the growing trend of businesses without the right level of cover. This article explains the risks of underinsurance and the importance of accurate information in your policy. 

What is underinsurance? 

Underinsurance is when your insurance policy doesn’t cover the full cost of replacing your assets or protecting your business if something goes wrong. It means you might not get enough money to fully recover from a loss, leaving you to cover the shortfall. It can also mean any payout you do receive could be reduced by the percentage you’re underinsured.

This could mean you’ve underestimated the amount of your stock or business equipment you’d like to insure – so your policy can only pay out a percentage of your claim. It can also mean underestimating the overall impact your professional advice could have, for example if a client makes a financial loss because of your work. 

What does this mean in practice? Claim payouts may be reduced proportionally if an asset is underinsured (insured for less than its full rebuilding or replacement cost). If the amount you’ve insured is lower than the actual value, the insurer only pays a percentage of the loss equal to the level of coverage. 

Underinsurance – a growing risk

Three out of four small businesses are unprotected against everyday risks as a result of being underinsured, according to a report from Hiscox. The Global Protection Report also found that around a third of small business owners surveyed hadn’t reviewed their insurance policies in the last three years, and any new risks as a result of business growth wouldn’t be reflected in their policy. 

While we all hope we won’t have to rely on insurance, it’s important not to just buy it and forget about it when it comes to protecting your business. Changes like growing revenue, hiring new staff, and launching new products can introduce new risks and may mean you need to update your policy. 

Why are businesses underinsured? 

Underinsurance is rarely deliberate and it can be caused by a range of factors. For example: 

Ignoring inflation – inflation and other geopolitical factors have pushed up the cost of building materials, labour, and stock. This can mean the cost you originally estimated for a loss or disaster isn’t enough to cover you. 

Cost cutting – we all look for ways to save money, but sometimes that can come at a cost. Lowering your insurance premium by reducing the cover level can mean you’re not inaccurately representing your business, which could result in claims being rejected.

Lack of understanding – some small businesses aren’t clear about what different insurance covers are for, meaning there are gaps in policies where risks haven’t been identified. Hiscox found 65 per cent of business owners were unable to accurately describe what public liability covers, and this increased to 77 per cent for cyber and 80 per cent for professional indemnity. 

Auto renewing without checking – your business changes over time, whether that’s growth, staffing, or new equipment, so it’s important to check if the policy still suits you when renewing. 

5 implications of underinsurance

1. Financial losses – you might need to pay some of the costs of damages, losses, or liabilities if you don’t get enough compensation through your business insurance. 
2. Business interruption – not having the right cover could mean you can’t recover lost income as a result of a disaster or accident. 
3. Legal and compliance risks – some industries and contracts require you to have a certain level of cover, so if this isn’t accurate then you might not be compliant.
4. Reputational damage – failure to recover quickly from an incident due to insufficient insurance can harm a business’s reputation with customers, suppliers, and stakeholders.
5. Inability to rebuild or recover – in the worst cases, you might not be able to cover the cost of the shortfall if there’s a claim that doesn’t cover the costs. 

Examples of underinsurance

Sam started her bakery business at home in her kitchen. She grew her business so much that she needed to find a premises and hire an assistant. However she didn’t update her insurance provider about a new business address and failed to take out employers’ liability insurance – a legal requirement for most businesses when taking on staff. These oversights mean she’s underinsured and could risk being out of pocket if a claim were to be made against her business. She may also be fined if she’s found to be not complying with the law when it comes to employers’ liability cover. 

Oscar runs a small accounting firm and recently started taking on bigger clients with more complex accounts. However, he didn’t update his professional indemnity insurance policy to reflect this change in scope. When a client filed a claim against his firm for an error in financial reporting, Oscar discovered that his policy didn’t cover the full cost of legal fees and compensation. As a result, Oscar had to pay a significant portion of the claim out of his pocket, putting a strain on his business finances and reputation. This oversight could have been avoided with a regular policy review and accurate disclosure of his business operations.

Key questions to avoid underinsurance

1. Do I have the right covers for my business? 

Consider public liability, business interruption, cyber, professional liability, stock, tools, and anything else you might need to protect your business. 

2. Are my cover limits enough to cover the worst-case scenarios? 

Work out how much it might cost if your business suffered a major loss or other event.

3. Have I reviewed my insurance policies in the last 12 months? 

Regular reviews of your policy make sure your cover reflects your business needs.

4. Has my business grown or expanded recently? 

Revenue growth, more employees, or additional premises might mean you need a higher cover limit.

5. Do I have an accurate inventory of my physical assets – and how much would it cost to replace these?

Look at equipment, inventory, furniture, and other items, and consider how much it would cost (bearing in mind inflation) to replace these.

Small business guides

• Avoid these 4 risks to help protect your business’s reputation
• Ask the experts: how to find the best business insurance for you
• Why insurance claims get delayed (and how to avoid it) 
• What is turnover in business and how do you calculate it?