Underinsurance: What happens when your property is underinsured and experiences a total loss?

Being underinsured in a ‘total loss’ property claim can have dire financial consequences. Whether deliberate or not, about 25% of property owners don’t insure their buildings for the correct replacement value. 

It can however be complex arriving at the correct figure. This article explains how you can settle on accurate building and contents sums insured – without relying on guesswork.

How is total loss defined?

This term, also known as ‘actual total loss’, indicates there’s nothing to salvage, even for repairs. In the event of a such a loss, your sums insured should allow for full replacement and reinstatement of your property – this is what you need to consider when selecting your sums insured.

Another useful term to know is ‘constructive total loss’. That’s when the estimated repair costs exceed the property’s insured value. In this instance, the insurer may pay out the policy or rebuild the property. Constructive total loss also refers to an insurance claim settled for the full value of the policy.

The risks of underinsuring your property 

Underinsuring your property means you’re not adequately protecting your assets. This can be a major issue in a total loss.

As a yardstick, if your insurance policy covers 80-90% or less of your building & contents replacement costs, you are underinsured. In other words, if you suffer damage or loss, the insurer will only reimburse you up to your Sum Insured. If your Sum Insured is not adequate, you will have to pay the shortfall.

For many, this could mean that there won’t be enough funds from the insurance settlement to rebuild the property and furnish it to the same standard as the original.

Stop and think:
If you experienced a total loss, would your savings cover the cost to rebuild and furnish your building? For most, it is highly unlikely, making it essential to have sufficient insurance coverage in place.

Factors that can lead to underinsurance

  • As you accumulate more possessions and upgrade your assets, you may forget to update your insurance cover.
  • Underestimating building costs are a common cause of underinsurance. At present, building costs will continue to increase due to demand, the impact of the pandemic on supply chains, and new compliance standards from local, state and national authorities.
  • Major catastrophic events impacting large populations e.g. bushfire or flood can make tradespeople difficult to source. This can increase costs due to high demand, scarce building materials and delayed building work. Insurers however often have contingency plans for such circumstances.

The importance of valuing your property correctly 

Underinsurance
As explained above, if you are underinsured, it means you have paid for an insurance policy that doesn’t cover the full cost of your potential loss or the financial impact on yourselves and your family. It means that in a total loss you will have to pay for the additional cost of replacement over and above the nominated sums insured. This can be financially devastating, and underscores the importance of accurate coverage levels.

Overinsurance
If you overinsure your assets – that is, for more than their replacement cost – you’re overpaying for insurance. There are no additional benefits for you to fork out a higher premium where the property’s value doesn’t warrant it – the Insurer will still only pay up to the necessary amount to replace and reinstate the property.

Tips to avoid underinsurance

Avoid some common mistakes property owners often make in valuing their properties. Consider the following:

  • Review and update your sums insured.
  • Do not assume the resale value of the property is the same as the cost to rebuild it.
  • Do not rely on a bank, architect, builder, real estate agent, tax assessor, accountant, or engineer – consult with a professional quantity surveyor or speak to an insurance broker about how to achieve an accurate valuation.
  • Do not deduct land value from financial valuation reports.
  • Go beyond the primary structure when setting a sum insured. In addition to the main property, consider what it would cost to replace driveways, retaining walls, pools, landscaping, fencing, foundations, or other inside or outside property elements that need coverage.
  • Be specific to your property, don’t just adopt a book value or refer to building guides.
  • Factor in new purchase prices, not second hand or the price it was 10 years ago – inflation makes a big difference.
  • The real installation and commissioning costs.

Getting your sums insured right 

When nominating your sums insured, the onus is on you to get it right. However, with complex insurance policies and online home contents/building calculators subject to a disclaimer, this can be difficult! A professional valuation by a quantity surveyor is vital to help protect your assets.

Additional to valuing the property itself, keep an accurate, up-to-date inventory of your possessions, the assets you keep in your building and on the premises, to account for new-for-old replacement costs. Ensure you detail valuables, particularly those you carry with you in and out of your home, such as laptops or other devices. A contents calculator can help to get you on your way.

Ensure you’re correctly insured – speak to an insurance broker

Insurance is one of the best strategies to manage property risks. A CBN insurance broker can organise an insurance appraisal on your behalf and guide you through the considerations as they relate to your property insurance. This would factor in the direct costs to rebuild your asset with the same sort of quality materials, but also the indirect costs, including permits, consulting fees, architects, engineers etc. If the building is dated or has heritage features, it may need upgrades that meet current building code requirements – another additional cost to account for. And, if your building is on a steep incline or in a high-density area, then bracing and safety measures should also be considered for any demolition and rebuilding.

CBN insurance brokers are here to help and can tailor an insurance program for you. They will explain the finer details about what insurance covers, and why failing to verify the value can cost you in the long run. With accurate insurance, you’ll effectively transfer your financial risk of building damage to the insurer, helping you rest easy when things don’t go to plan.

For professional insurance advice, connect with a CBN Authorised Insurance Broker.

Connect with a CBN Broker

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