The most common causes of underinsurance in property cover

Underinsurance is often discussed as if it were the result of a single mistake. In practice, it is usually the product of a number of contributing factors that develop over time. As BCIS executive director Rich MacLean explains, by the time a claim occurs, the gap between the sum insured and the true cost of rebuilding can already be significant. Across the industry, these contributing factors tend to fall into a number of common patterns and understanding those patterns is an important step towards reducing the problem.

1. Confusing market value with rebuilding cost

One of the most persistent causes of underinsurance is the assumption that a property’s market value is closely related to the cost of rebuilding it. In practice, the two figures measure very different things and are influenced by separate factors.

Market value reflects the price a property could achieve if sold on the open market. For a given asset, value is driven first by the location and scarcity of the land, and then by the nature and quality of the property built on it, as well as local demand.

Reinstatement cost, by contrast, reflects the cost of rebuilding the property from scratch following a loss. This includes the cost of labour, plant and materials required for construction, demolition and site clearance, professional fees and the cost of meeting current building regulations.

Historically, the gap between market value and rebuilding cost was often narrower in many parts of the housing market. That may have reinforced the perception that the two figures move together. However, they have always measured different things, and the relationship between them has weakened over time as land values and demand have played a larger role in determining property prices.

Although the two figures may sometimes move in similar directions, there is no consistent or reliable relationship between them. When market value is used as a proxy for rebuilding cost, the sum insured is often set too low, increasing the risk of underinsurance. In some areas, the divergence can produce cases of overinsurance.

2. Relying on outdated valuations

Even when a reinstatement cost assessment was accurate at the time it was carried out, it will not remain so indefinitely. Construction costs change. Materials prices fluctuate. Labour availability shifts. Building regulations evolve.

In some cases, these changes can be particularly pronounced. Properties that rely heavily on materials such as steel and concrete, for example warehouses, can see rebuilding costs shift significantly over a relatively short period. This risk is currently heightened, as volatility in the energy market has the potential to feed through into the cost of energy-intensive materials.

If a property has not been reassessed for several years, there is a strong possibility that the original figure no longer reflects the true cost of rebuilding, increasing the risk of underinsurance. Professional guidance therefore recommends carrying out a full reassessment at regular intervals rather than relying indefinitely on historic valuations.

3. Treating indexation as a substitute for valuation

Index linking plays an important role in maintaining adequate cover between valuations. However, it only works effectively when the original sum insured was correct. If the starting figure is too low, applying indexation simply increases an already inaccurate number. Over time this can create a false sense of security while the gap between the insured value and the real rebuilding cost continues to grow.

Even where the correct sum insured has been established, the choice of index remains critical. Using a generic or inappropriate index can result in movements that do not reflect the actual cost of rebuilding a specific asset. Indexation should therefore be seen as a maintenance mechanism rather than a substitute for reassessing reinstatement costs.

4. Property changes that are never reflected in the policy

Another common issue is that properties evolve over time. Extensions, loft conversions, upgraded finishes and additional external structures can all increase rebuilding costs.

Where those changes are not reflected in a reassessment of reinstatement value, the insured amount may remain tied to the original configuration of the building rather than the property as it exists today. Over time this creates a growing mismatch between the policy and the physical asset.

5. Incomplete or outdated property data

The quality of the data used to determine reinstatement costs also plays an important role. In portfolio situations in particular, properties may be insured based on aggregated values or incomplete records of size, specification or construction type.

Without accurate property information it becomes difficult to produce a reliable reinstatement cost in the first place. In these situations, the problem is less about valuation methodology and more about the quality of the underlying asset data.

Why the factors often combine

In most cases, underinsurance does not arise from just one of these factors.

More often it is a combination. An outdated valuation may be adjusted using indexation for several years. During that time the property itself may change, while the wider construction cost environment evolves in the background.

By the time a claim occurs, the original assumptions behind the sum insured may be several steps removed from the current reality.

Reducing the risk

Reducing underinsurance does not necessarily require new tools. The industry already has well-established approaches to assessing rebuilding costs.

The challenge is ensuring those approaches are applied consistently. That means:

• clearly distinguishing reinstatement cost from market value
• reassessing properties periodically
• keeping a record of how and when assessments were carried out
• applying indexation appropriately
• keeping property records up to date

None of these steps are complicated on their own. But when they are overlooked, even relatively small gaps can compound into significant shortfalls over time.

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