Underinsurance is the quiet problem in Australian business insurance. Values set years ago, construction costs that have risen sharply, plant that costs far more to replace than it did — and a clause in the policy that turns the shortfall into your share of every claim.
What the Clause Does
Many property, plant and business packages contain an average or co-insurance clause. In effect, if you insure for materially less than the full replacement value, the insurer pays only the proportion of the loss that your sum insured bears to the correct one.
A Worked Example
Suppose a workshop and its contents would cost $2,000,000 to replace, but the sum insured is $1,200,000 — 60 per cent of the true figure. A fire causes $400,000 of damage.
- Without an average clause: the insurer pays $400,000, less the excess.
- With average applied at 60 per cent: the insurer pays $240,000, less the excess.
The $160,000 difference is not a penalty. It is the share of the risk the business kept by insuring for less. Many wordings only apply average where the shortfall exceeds a threshold, but the direction is the same.
Where It Bites Hardest
- Buildings, where replacement cost has moved faster than valuations.
- Plant and equipment schedules, where machines are carried at written-down book value rather than replacement cost.
- Stock, where peak season values exceed the declared figure.
- Business interruption, where the declared gross profit reflects last year’s turnover, not this year’s.
Book Value Is Not Insurable Value
Accountants depreciate; insurers replace. A ten-year-old excavator may be written down to very little and still cost several hundred thousand dollars to replace. Schedules built from a fixed asset register are one of the most common causes of underinsurance in plant programmes.
Do Not Forget the Extras
Replacement cost is more than the item. Consider demolition and removal of debris, professional fees, compliance with current building codes, freight and installation, and the time value of an extended rebuild. Each is a section on a well-built policy.
How to Keep Values Current
- Review sums insured at every renewal, not every few years.
- Get a formal replacement cost valuation for significant buildings.
- Price plant against what a replacement machine actually costs today.
- Set business interruption on forward-looking gross profit and an honest indemnity period.
- Tell your broker when you buy, build or expand — mid-term is fine.
Why Values Drift Without Anyone Deciding To
Nobody sets out to be underinsured. It happens quietly, in four ways:
- Indexation that lags reality. An automatic uplift of a few per cent does not keep pace with construction costs that moved much faster.
- Rollover renewals. Last year’s schedule becomes this year’s without anyone re-examining it.
- Growth between renewals. New plant bought in March that nobody added until the following February.
- Book values in the schedule. Depreciated figures carried across from the fixed asset register.
The Interruption Trap
Business interruption is where underinsurance does the most damage, because two settings can be wrong at once. If declared gross profit is understated, average reduces the claim. If the indemnity period is too short, the policy simply stops paying while you are still recovering.
Think about the real timeline after a serious loss: site clearance, insurer assessment, design approvals, council or certifier processes, construction, re-equipping, recruiting, and then the months spent winning back customers who went elsewhere. For anything involving a rebuild or long-lead plant, twelve months is often optimistic.
A Ten-Minute Annual Review
- Would today’s cost rebuild the building, including demolition, fees and code upgrades?
- Would the plant schedule buy equivalent machines at today’s prices?
- Does declared stock cover your peak, not your average?
- Is gross profit based on next year’s expected trading?
- Is the indemnity period long enough for the worst realistic recovery?
- Has anything been bought, built or added since the last renewal?
Six questions, once a year. It is the cheapest risk management in the programme.
Common Questions
Does average apply to a total loss?
On a total loss the sum insured is the cap regardless, so underinsurance shows up as a straight shortfall. Average is what reduces partial claims.
Is business interruption affected?
Yes, and often more painfully, because an understated gross profit reduces every part of the claim.
How long is an indemnity period supposed to be?
Long enough to rebuild, re-equip and get trading back to where it was. Twelve months is common and frequently too short for anything that requires construction or long-lead plant.
Talk It Through
A values review is a short conversation that occasionally saves a business. Get in touch or call 1300 983 940.
General advice only. This article does not take your objectives, financial situation or needs into account. Consider the relevant PDS and Target Market Determination before deciding on a policy.