Underinsurance in Commercial Property

Underinsurance has become an increasingly significant issue for commercial property owners in the UK. Many buildings remain insured based on reinstatement valuations that were carried out several years ago, yet construction costs have risen substantially during that time.

As a result, some properties may now be insured for less than their true rebuild cost. If a loss occurs, this can lead to unexpected financial exposure for property owners, landlords and asset managers.

Understanding the risks of underinsurance – and how to address them – is an important part of protecting the long-term value of commercial property assets. The data shows how important it is for property owners to work with a risk management specialist when insuring their property, as those who don’t are leaving themselves at significant financial risk.

What is underinsurance?

Underinsurance occurs when the sum insured on a property insurance policy is lower than the actual cost of rebuilding the property.

In the UK commercial property market, buildings are typically insured on a reinstatement basis. This means the sum insured should reflect the full cost of rebuilding the property following a major loss.

Reinstatement values usually include:

• demolition and site clearance
• rebuilding costs
• professional fees such as architects and surveyors
• compliance with modern building regulations

Importantly, the reinstatement value is often very different from the market value of the property. Market value reflects the price a property might achieve if sold, whereas reinstatement value focuses purely on the cost of rebuilding the structure.

Why underinsurance is becoming more common

Several factors have increased the risk of underinsurance across the commercial property sector.

Construction cost inflation

In recent years, labour shortages, rising material costs and supply chain pressures have all contributed to increases in construction costs. These changes mean that reinstatement values can rise significantly over relatively short periods of time.

Outdated reinstatement valuations

Many properties continue to rely on valuations that were carried out several years ago. Without periodic reviews, sums insured may no longer reflect current rebuilding costs.

Portfolio changes

For property investors and landlords managing multiple assets, insurance programmes may not always be updated when properties are refurbished, extended or redeveloped.

Incorrect valuation methods

In some cases, buildings are mistakenly insured based on their market value rather than their reinstatement value.

The impact of the average clause

Most commercial property insurance policies contain what is known as an Average Clause.

This clause allows insurers to reduce the amount paid on a claim if the property is underinsured. The reduction is applied in proportion to the level of underinsurance.

For example:

If a building should be insured for £4 million but is only insured for £3 million, the property is 25% underinsured.

If a claim of £1 million occurs, the insurer may only pay £750,000, leaving the property owner responsible for the remaining £250,000.

Importantly, the Average Clause can apply even if the claim is significantly smaller than the total value of the building.

Which Properties are most at risk?

While underinsurance can affect any property, certain types of commercial assets may be particularly vulnerable.

These include:

• retail properties and shopping centres
• mixed-use developments
• older commercial buildings
• properties that have been refurbished or extended
• multi-let commercial properties

Buildings with complex construction or heritage features may also have higher reinstatement costs that are not always fully reflected in existing insurance valuations.

How property owners can reduce the risk

There are several steps that property owners, landlords and asset managers can take to reduce the risk of underinsurance.

Regular reinstatement cost assessments

Professional reinstatement valuations carried out by qualified surveyors can help ensure buildings are insured for the correct amount. These assessments are typically recommended every three to five years.

Index linking

Many property insurance policies include index linking, which adjusts the sum insured each year in line with construction cost indices. This helps keep values aligned with inflation between formal valuations.

Portfolio reviews

For investors with multiple properties, regular insurance programme reviews can help ensure that sums insured reflect any changes to the portfolio.

Professional advice

Insurance brokers and surveyors can work together to help property owners review reinstatement values and ensure that policies provide appropriate protection.

Protecting the value of your property assets

Commercial property insurance is designed to protect the long-term value of a building and the income it generates. However, this protection only works effectively when the sums insured accurately reflect the true cost of rebuilding the property.

Regular reviews of reinstatement values and insurance arrangements can help property owners avoid the financial consequences of underinsurance and ensure their assets remain adequately protected.

Get in touch

If you would like to review your current property insurance arrangements or discuss whether your buildings may be at risk of underinsurance, our team would be happy to help. Contact info@eig.biz or call 0207 939 7200.