30 JAN 2025 
10 MIN READ
Making a claim on your business insurance is already stressful enough, and the last thing you want to hear when that happens is that your insurance won’t cover a total loss. For some customers, this is a very real consequence of underinsurance.
But, not to worry, this guide will tell you some of the risks and pitfalls of underinsurance, how to avoid it, and what the consequences are.
Helpful definitions
Total loss
When your premises and everything in it is completely unsalvageable.
Reinstatement value
The total cost of completely rebuilding your property if it’s destroyed and replacing everything inside to an acceptable standard. Consider things such as inflation, product value, changing building standards etc. See also: rebuilding cost.
Assets
Items that your business owns or controls. These can be tangible assets (such as a building, stock, or contents) or non-tangible.
Indemnity period
The length of time that your business is likely to be affected a loss. This period should be calculated from the date of damage/loss and cover the entire time you anticipate your business being affected. It can last no longer than your maximum indemnity period.
Gross profit
The selling price of your product minus the cost of producing it.
Mid-Term Adjustment (MTA)
A change to your policy made at any point after your purchase date but before renewal.
Rebuilding cost
The total cost of completely rebuilding your property if it’s destroyed and replacing everything inside to an acceptable standard. Consider things such as inflation, product value, changing building standards etc. See also: reinstatement value.
What is underinsurance?
Underinsurance happens when you’ve not properly calculated how much it would cost to replace everything in your business if you need to make a claim.
When you’re buying insurance, you need to work out the reinstatement value of everything relating to your business – assets, contents, property etc., and any possible associated costs that could build up while your business is out of play.
If you insure your property for a value that is under the actual cost of repairs, replacements, and rebuilding – you are underinsured.
How do I know if my business is underinsured?
Figuring out if you’re underinsured isn’t as difficult as you might think - and if you’ve not reviewed your figures in a while then it’s something you need to consider doing.
When reviewing your figures, these are the 3 areas to consider and the questions you should be asking yourself.
Have I considered all of my assets?
- My contents?
- My stock?
- My machines, tools and office equipment (such as laptops etc)?
- My decorative elements like shelving, displays, lighting, etc?
Have I considered my building costs?
- Including the actual bricks and mortar building?
- The cost of damage to any connected buildings?
- The cost of clearing the site and removing any debris?
- Hiring professionals like a surveyor, architect, interior designer etc?
- Labour costs to hire builders and painters/decorators?
- The cost of materials to physically rebuild the business?
- How long it will take to fully recover after a loss? And is this within my indemnity period?
- Have I considered things that might hold up the time it takes to get back on my feet?
- Is my building considered historic, or is it an unusual building?
- Will I need specialist materials or professionals?
- Are there any issues with supply chains, or a shortage of materials?
- How long will it take to get designers and contractors?
- Are there any labour shortages or planned strikes?
- Is there any reason why my planning permission might be delayed?
- Is my gross profit figure correct?
- Have I accounted for the loss of income while the business is closed?
- Have I accounted for the loss of rent?
- Have I accounted for the economic factors?
- Am I keeping my staff on? And if so, have I accounted for their wages?
- Has it been longer than 12 months since I had a proper valuation?
- Has anything happened in recent times to affect the figures I originally calculated?
- Has inflation risen? Fallen?
- Has there been any global events that might have affected things?
- Has my business grown in size? Have I downsized?
- Have I kept all of my receipts and invoices so that I have an accurate cost per item?
Please note: if you’re unsure how to calculate the bricks and mortar rebuild cost for your building, you can use the Association of British Insurers (ABI) Public Rebuild Calculator to help you arrive at the correct figure.
What happens if you’re underinsured?
Being underinsured might not feel like a big problem when things with your business are going well, but if something does go wrong you’ll be in a sticky situation.
There are 3 major consequences of being underinsured:
1
Receiving a reduced payout
The most obvious consequence is that the payout you get on your claim won’t be as high as you expect it to be. In most cases, it likely won’t be enough to cover the cost of fixing up your business.
This means that instead of getting your business back on its feet quickly, you might only be able to get some of the initial work done before you need to find an alternate source of funding.
2
Having to fund the rest of the repair or rebuilding work by yourself
If your insurance payout is lower than you expect due to being underinsured, you’ll need to get the rest of your funds elsewhere.
In most cases, this means funding the rebuild personally or through your business’ savings or profits. This causes unnecessary stress and might even be an impossible task for some smaller businesses.
3
Possible voiding of your policy
In some cases, your policy might actually be considered void if an insurer considers you to be severely underinsured. We call this failing to make a ‘fair representation of risk’, which tends to happen when you’ve significantly underestimated the value of your assets or have misrepresented your business in some way – whether that was on purpose or not.
If your policy is declared void, not only will you receive no payout, but you’ll be left with no business insurance either.
Examples of underinsurance
To help you understand what this could mean if it came to a claim, let's take a look at some examples.
In each of these scenarios, you'll see how a simple misunderstanding of what to include in your figures can lead to considerable underinsurance in the event of a claim.
You paid £50,000 to buy an industrial unit, but its rebuilding cost may be £150,000
If you insure it for £50,000, you are underinsured. You should insure the unit for the rebuilding cost of £150,000
You buy a second-hand piece of machinery at an auction for £4,000, however, it costs £10,000 to buy it new if anything happens to it.
If you insure it for £4,000, you are underinsured. You should insure the machine for £10,000, since you’ll probably have to buy it new if it breaks down.
You buy an older property for your store for £100,000. If anything happens to the building, it would now cost £250,000 to rebuild it to a modern property standard. Your business sells clothing, so you keep up to 6 months of stock on hand at any one time. The retail value of the stock is £15,000, but the production value is £8,000.
Remember, all assets must be included, and stock must be insured at it's production value, not it's sale value.
So, if you insure for either £100,000 or £15,000, you are underinsured. You should insure for £258,000 – this is the the total cost of rebuilding + the production cost of your stock.
You invested in various pieces of good quality design and printing equipment to set up a small jewellery business at home. It cost you £3,000 to buy second-hand a few years ago, but to replace every piece brand new, you would pay £7,000.
You hand craft all your pieces and have over £2,000 worth of materials and packing supplies.
All assets must be considered in your insurance total. So, if you insure the items for £5,000, you are underinsured as you've not included the cost of your materials. You should insure for £7,000 - the cost of replacing your equipment from new + the cost of your materials, packing supplies etc.
How to value your items properly
To understand just how many things need to be added to that final figure, let’s walk through a possible scenario.
We want you to imagine:
You own an independent bookshop located on the local high street.
It’s a standalone store opening onto the busy street, with a small courtyard at the back for deliveries.
Now imagine a fire has broken out during the night, and you’re assessing the damage.
The figure you’ve insured for should be enough to cover the end to end recovery of your business. To get to this figure, it helps to start from the beginning. The important thing to remember is this:
Everything you encounter after a loss must be accounted for in your final figure.
1
You get to the bookshop to see it’s burned out and is a total loss.
How much will it cost to:
- Clear out the building and remove all the debris
- Knock down the building
- Prepare the site for rebuilding
- Clear any debris from the back courtyard
- Compensate nearby businesses if they have suffered damage
2
Now that the site is clear, you can start rebuilding your shop.
How much will it cost to:
- Apply for planning permission
- Hire an architect to design the plans
- Hire builders, plumbers, electricians etc to work on the building
- Get the materials needed to rebuild
- Make sure the building is rebuilt to the current government regulations and building standards
3
While that’s all going on, how are you handling business interruption?
Have you considered:
- Being out of business for weeks or months
- Any delays to recovery
- Issues with supply chains or shortages of certain materials
- Strikes or labour shortages
- Loss of rent and loss of income
- The changes to inflation
- Changes to the business since the original figure given gave an insurer
- Paying any staff's wages while the business is closed
4
Now that your business has been rebuilt, it’s time to get ready to reopen.
How much will it cost to:
- Paint and decorate the shop
- Fit new shelves, displays, seating areas and lighting
- Set up the cash desk, computers, phone lines
- Replace all the contents and stock for the shop
- Replace all the essential office equipment
Running through this scenario can help pinpoint everything that should be considered in your final total sum insured.
Underinsurance FAQs
When you make a claim on your insurance, your insurer will only pay out based on the level of cover you’ve chosen and the figure you’ve supplied as rebuilding cost.
If the figure you supplied doesn’t reflect the actual cost of restoring after a loss, then the payout you get won’t be enough to cover the costs of rebuilding. Your insurer won’t alter your payout based on the actual rebuild cost, so you must provide an accurate figure at the time of purchase.
Yes, all sums can be adjusted using a mid-term adjustment (MTA), so if you realise midway through your policy that your figures are wrong, or your circumstances change suddenly, you can make sure you’re still covered.
However, make sure your figures are accurate before adjusting. You should never reduce your sums insured simply to save money on your premium because, as this will leave you underinsured and cost you much more in the long run.
Protect your business with AXA and Future You will thank you
If you’re ready to start your own business and make your hobby into a money spinner, AXA is there for you if the worst should happen.
With a range of covers you can tailor to your own business’ needs, get covered today and Future You will be thankful.
*https://www.rebuildcostassessment.com/post/annual-infographic-2024
All links are checked and valid at time of publishing, 30 January 2025.