Are many businesses under insured when it comes to recovering from a serious fire?

Business owners often make the mistake of insuring for the market value of the property, rather than the full cost of a rebuild. Market value is often not an accurate reflection of the cost to rebuild a premises, and other features such as car parks, driveways, lighting, fencing, and gates are often overlooked (Cockburn, 2022). When calculating rebuild costs, estimates should include materials and labour, professional fees such as architect and planning costs, legal fees, demolition or make-safe costs, site clearance and access costs. If the property is a listed building, it will typically take longer and cost more to rebuild, as these buildings must use specialist materials and traditional construction methods (“Calculating your rebuild cost | ABI,” n.d.). Buildings that are furnished to an unusually high standard (including those with eco-friendly features) or that have been constructed using unconventional materials may also be more costly and time consuming to rebuild (Cockburn, 2022).

Furthermore, insurers can apply the ‘Average Clause’ to claims made by underinsured businesses, which can result in a lower settlement amount than the policy limit. If an insurer discovers that a business has inadequate insurance, the settlement can be reduced by the same percentage as the asset is underinsured (Joraschkewitz, 2022).

Claims Example with the Average Clause Applied

One example presented in an article by Cockburn explains the following: Business A has stock with a total value of £100,000. When taking out insurance, the policyholder decides that they would be unlikely to lose more than 60% of total stock. Therefore, they take out a policy with a maximum of £60,000 cover, but do not inform the insurer of the total value of the stock. A fire destroys 50% of the stock, resulting in £50,000 of losses. The insurer deems Business A to be underinsured by 40% and applies the average clause. This results in Business A receiving only £30,000 (60% of the insured damages). This leaves Business A with a £20,000 deficit for the lost stock, which would have been covered if the policyholder had given an accurate stock valuation to the insurer upfront (Cockburn, 2022).

Furthermore, unexpected problems with a plant or machinery can be very costly, and it is important to consider not only the direct costs of replacing machinery or equipment, but all the costs associated with delays to production, fulfilment of orders and additional labour costs. The British Insurance Brokers’ Association (BIBA) strongly advises that all machinery (both hired and owned) is insured for the full value of replacing ‘new-for-old’. In addition, delays caused by any specialist machinery that would take a significant amount of time to replace must be accounted for.

Adding to this uncertainty, there is currently no simple yet scientifically robust method for calculating insurance loss estimates due to a warehouse fire (Porter, 2006). Therefore, building owners and insurers cannot make suitably informed decisions when selecting fire protection measures or setting premiums as they have no way of defining the true risk they face (Atkinson and Jagger, 1994).

Supply chain delays have been significantly exacerbated in recent years by a combination of factors, including the COVID-19 pandemic, BREXIT and the Ukrainian conflict. Yet, there are many scenarios that should be considered to fully understand how a business’s trading could be interrupted. From physical events such as a fire or flood to supply chain disruptions and cyber-attacks, multiple factors will inevitably influence how long a business would need before it resumes normal trading following a serious fire. Selecting a much shorter period of cover for business interruption than the likely period of actual disruption is a common oversight, leaving businesses with ongoing additional costs after insurance pay-outs have ceased (Cockburn, 2022). In times of strong economic growth, finding that a claim is being proportionately reduced as a result of underinsurance can make it difficult for a business to bounce back after a loss, especially from a serious fire . But, with many businesses struggling to get back on their feet after the pandemic and facing worldwide shocks from the current unstable conflicts in the Middle East and shipping threats, underinsurance could prove to be the final blow for some businesses (Allianz UK, n.d.).