Underinsurance: What Every Property Owner and Landlord Needs to Know
By Daniel Floyd, Client Director – Konsileo | Property Insurance Specialist
Most property owners and landlords have buildings insurance in place. Far fewer understand one of the biggest risks that can quietly undermine a claim: underinsurance.
This article explains what underinsurance is, why it is so common, and what you can do to protect yourself against it.
What Is Underinsurance in Buildings Insurance?
Underinsurance occurs when the sum insured on a buildings policy is set too low – lower than the actual cost of reinstating the property following a major loss.
It does not mean you have no insurance. It means the figure your insurance is based on does not accurately reflect what it would cost to rebuild.
What Is the Average Clause and How Does It Affect a Claim?
Most commercial and residential property policies contain an average clause – sometimes called a condition of average.
This clause means that if a property is underinsured, the insurer can reduce any claim settlement proportionally. The insurer is not obliged to pay the full cost of a loss – only the proportion that reflects how much of the correct sum insured is actually in place.
Worked example:
- True reinstatement cost: £1,000,000
- Sum insured on the policy: £700,000
- The building is insured for 70% of its true reinstatement cost
If a partial loss occurs – say a fire causes £200,000 of damage:
- Without the average clause, you might expect to receive £200,000
- With the average clause applied, the insurer may pay only 70%: £140,000
- Shortfall to the policyholder: £60,000
That shortfall falls on you – the property owner – not the insurer.
Why Does Underinsurance Happen?
Underinsurance is rarely deliberate. It usually happens for one or more of the following reasons:
- The original sum insured was set too low – perhaps based on a rough estimate, the market value, or a figure that was never properly calculated
- The sum insured has not kept pace with rising construction costs – materials, labour and professional fees have all increased significantly in recent years
- Index-linked increases have been relied on too heavily – automatic annual uplifts adjust the sum insured in line with a general construction cost index, but cannot account for property-specific changes or above-average inflation
- A professional reinstatement cost assessment has never been carried out – or has not been carried out for a number of years
Why Is This Particularly Important Right Now?
Construction costs in the UK have risen significantly in recent years. The combination of material price increases, labour shortages, supply chain pressures and inflation has meant that buildings that were adequately insured a few years ago may no longer be.
If you last reviewed your reinstatement cost two, three or more years ago, there is a real risk that your sum insured no longer reflects the current cost of rebuilding.
How Does Underinsurance Affect Blocks of Flats?
Blocks of flats and larger residential or mixed-use buildings are particularly exposed to underinsurance because of the complexity of calculating an accurate reinstatement cost.
A full assessment must account for much more than the individual flats. It also needs to include:
- Communal areas, hallways, stairwells and entrance lobbies
- Shared services such as heating, water infrastructure and electrical installations
- Lifts, plant rooms and mechanical and electrical equipment
- Specialist or heritage architectural features
- Demolition and debris removal costs
- Professional fees for architects, engineers and project managers
- Compliance with current building regulations, which may be considerably more demanding than when the building was originally constructed
For freeholders, resident management companies (RMCs), right-to-manage (RTM) companies and property managing agents, an accurate reinstatement cost is not just good risk management – in many cases, it is a legal requirement under the terms of the lease.
How Can Property Owners Protect Themselves Against Underinsurance?
The most effective protection is a professional reinstatement cost assessment carried out by a qualified surveyor. This establishes the correct rebuild cost based on the specific characteristics of the property and current construction costs.
As a general guide:
- Properties should be professionally reassessed at least every three to five years
- A reassessment should follow any significant alteration, extension or improvement
- A period of significant construction cost inflation is a trigger for an immediate review
For smaller properties, the RICS BCIS calculator provides a useful starting estimate. For larger, older, listed or more complex buildings, a full professional assessment by a chartered surveyor is strongly recommended.
Frequently Asked Questions
Underinsurance means the sum insured on your buildings policy is lower than the actual cost of reinstating the property. This can result in a reduced claim settlement, with the shortfall falling on the property owner.
The average clause (also called the condition of average) is a policy provision that allows the insurer to reduce a claim settlement proportionally if the property is underinsured. If the sum insured is 70% of the true reinstatement cost, the insurer may pay only 70% of any claim.
If your policy contains an average clause - which most commercial and residential property policies do - an underinsured property may result in a significantly reduced payout, even on a partial loss. The shortfall is borne by the policyholder.
The most reliable way is to obtain a professional reinstatement cost assessment from a chartered surveyor. If your sum insured has not been reviewed for several years, or was never professionally assessed, there is a genuine risk it no longer reflects current rebuild costs.
Not fully. Index-linked increases adjust your sum insured in line with a general construction cost index, but cannot account for property-specific changes, periods of above-average inflation, or an original sum insured that was already set too low.
As a general guide, every three to five years - or sooner following significant works, a change in use, or a period of significant construction cost inflation.
Yes. It is one of the most widespread and costly issues in UK property insurance, affecting landlords, commercial property owners and residential leaseholders alike. Many properties are underinsured simply because their sum insured has never been professionally assessed or has not kept pace with rising construction costs.
What Should Property Owners Do Next?
If you own or manage residential, commercial or mixed-use property, there are two questions worth asking yourself now:
- When was my building last professionally valued for reinstatement cost?
- Am I confident that my current sum insured reflects what it would actually cost to rebuild today?
If you are not certain about the answer to either question, it is worth reviewing your arrangements with a specialist broker who can help you establish whether your buildings insurance is fit for purpose – and, where appropriate, arrange a professional reinstatement cost assessment.
Daniel Floyd is a Client Director at Konsileo, specialising in property insurance, high net worth insurance, hospitality insurance and retail insurance.
If you would like to discuss your property insurance arrangements, please get in touch.
