Underinsurance: Cost-Cutting at a Heavy Price
August 11, 2016
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Overall portfolio of clients’ risks insured in 2016
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Lately there have been some developments in the sphere of issuing loans to businesses secured by pledged property assets. Though the process is not as speedy as some of companies would have wished, that is still a positive trend for the economic revival. Typically enough the majority of lenders view the compulsory insurance required under the mortgage agreements as the unintended expenses. Therefore only the slight share of attention is paid to considering and negotiating the most favorable insurance terms and conditions instead of using the insurance policies as the tool to minimize the entrepreneurial risks.
This article is aimed at warning the readers against three typical mistakes in terms of underinsurance which are most common for insurance policies.
First of all it’s best to define the essence of underinsurance. That is a situation in which the sum insured under the agreement does not correspond with the real value of the insured object. That means that under any circumstances an Insured is entitled to the insurance indemnity which is always smaller than the incurred loss. However many clients believe that this is relevant only to total loss cases. That is not true.
When does the underinsurance take place? There are plenty of options, but the key reasons are as follows.
Reason # 1. Sum Insured is based on the bank estimates of the property value. Usually banks tend to lower the real value of the mortgaged property. Their core concern is to ensure that the collateral property could be sold in case of the delinquent loan. Real value of your property is the least of bank’s worries as its objective is to hedge not yours, but its risks.
Reason # 3. Lack of financial awareness and insufficient experience in claims settlement. Here is a real life example. The greenhouses were insured for UAH 10 mln with their real value being equal to UAH 20 mln. The underinsurance coefficient constituted 0.5. During the term of insurance the greenhouse suffered from fire which brought around UAH 5 mln. worth of losses. We neglect the deductible to simplify the calculations in this case. Which indemnity do you think the Insured was entitled to? Do you believe it should have been UAH 5 mln? Alas, only UAH 2.5 mln, as only half of the losses are covered if the object is insured for only half of its value.
Let’s take another example. The retail chain of 25 stores selling household goods carries stock worth of UAH 15 mln at each location. Bank approved the loan secured by the pledged goods. The Insured decided to conclude the insurance agreement for UAH 15 mln. defined by the bank instead of insuring all goods located in all 25 stores. Naturally, the underinsurance in such case is significant which will inevitably result in much smaller coverage of losses suffered due to any of the insured events.
The lesson of the above is the following. If you intend to cover your losses in full with the help of insurance, it’s best to make sure that the sum insured is relevant to the real value of your property. Otherwise you are bound to pay partly for damage yourself.
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