Don’t let underinsurance come back to bite you when you claim!

16 April 2021

The application of average is an age-old insurance principle, which is often not known (or understood) until it’s too late!

Basically, the application of average, relates to underinsurance. There is a common misconception that underinsurance only affects your claim in the event of a total loss, when you would not receive the full value of your loss. But that is simply not true. When a loss occurs, if the policyholder has not disclosed the full value of what is being insured, the claim is adjusted to take into account the level of underinsurance.

Underinsurance essentially results in the policyholder paying lower premiums than should have been paid. Thus, when insurers receive a claim and it turns out that the policyholder is underinsured, the payable amount is adjusted to reflect the lower premiums that were paid. If a policyholder had been underinsured by 50%, for example, the settlement would be reduced by 50% – this is known as the application of average. In other words, if you insured a building worth R2 million for R1 million and submitted a damages claim of R100 000 you would only receive R50 000 if you were underinsured by 50%.

When times are tough – as they currently are – businesses tend to take a hard look at their expenses and insurance covers are often reduced in order to save costs. However, as indicated above, saving a few thousand rand in reduced premium in the short-term could end up costing you a lot more – and even the sustainability of your business – in the long run.

It is also important to consider all the risks the business faces. According to Ian Labram, Executive: Motor Underwriting at Guardrisk, SA’s motor industry is traditionally underinsured, “choosing to focus on basic traditional insurances such as buildings and vehicles, while neglecting more volatile issues such as legal liabilities, defective workmanship, business interruption, fidelity and so on”. He adds that building and contents are also generally also underinsured in this sector.

Labram believes that, rather than a conscious decision to underinsure, the motor industry’s tendency towards underinsurance can often be ascribed to traditional insurance policies not covering all aspects of the sector’s risks. 

“No doubt there is always the balancing act between what the business can afford in terms of insurance premium versus the actual insurance needs, but often it is simply a matter of an off-the-shelf product being purchased, which is not suited specifically to the unique risks faced in this sector,” says Labram.

Guardrisk partnered with the Retail Motor Industry Organisation (RMI) twenty years ago to create a tailormade insurance product for the retail motor industry under the banner of RMI4Sure.

RMI4Sure gives policyholders a share in their own insurance programme, including the accrual of underwriting profits and the power of collective buying. While each business is evaluated according to its own risk profile and priced accordingly, the facility incorporates certain minimum levels of cover.

Labram says that, with RMI4Sure, cover can be customised according to the individual business’ requirements and structured to meet budget.

“Many businesses now request a larger deductible or excess structure to reduce pay-away premiums. For larger clients, a formal self-insurance contingency policy can be created, where the insured pays for all of their own losses up to an agreed quantum per event and an agreed limit during a specified period of insurance, usually 12 months,” he says. Guardrisk then effectively covers the loss above these agreed events and limits, at vastly reduced premiums compared to a conventional insurance structure

Another way that businesses can reduce premium spend is through a deposit premium structure. This is offered on larger annually paid policies and can deliver savings when the insured has a good year in terms of their insurance loss ratio.

For instance, the insured can agree to a deposit premium structure of 70/30, subject to a 60% claims burner. The insured then pays 70% of the annual premium upfront and only if the claims exceed 60% of that 70% does the remaining 30% of the premium become due. If the claims ratio stays below 60% of the 70%, the insured does not have to pay the “outstanding” 30% of the premium. Premiums would naturally be adjusted should risk or sums insured alter during the period.

Here’s how a 70/30 deposit premium structure would work on an annual premium of R200 000:

  • Client pays R140 000 (70%) up front
  • If claims exceed R84 000 (i.e. 60% of R140 000) the client is liable to pay the R60 000 (30%) of the premium
  • If claims don’t exceed R84 000 the R60 000 does not need to be paid.

Labram advises business to consider adapting a more innovative approach to their insurance programme, as opposed to simply reducing cover to save costs.