Under pressure from underinsurance: solutions to a reinstatement issue

Underinsurance in the context of buildings insurance is nothing new, but its presence has increased markedly since the Covid-19 pandemic.

Plant, labour and materials costs have all spiked in recent years, driving up the cost of reinstatement as a result. In many cases, the reinstatement cost of a property or portfolio is now higher than the original cost of construction.

With cost growth persisting, buildings insurance can quickly become outdated and where inaccurate data is used to calculate the original reinstatement value, underinsurance is likely.

In this landscape, the duty to use an accurate reinstatement value and ensure an appropriate level of cover is maintained rests on both the insurer’s and property owner’s shoulders.

A foundation for underinsurance

According to BCIS’s latest annual update to its residential rebuild models, reinstatement costs grew by 3.8% in the year ending in January 2025.

While the models are updated annually to a fixed January pricing base, costs are adjusted between updates using the ABI/BCIS House Rebuilding Cost Index (HRCI).

Calculated monthly and representing the UK average across property types, the HRCI ensures assessments reflect recent cost movement. The latest HRCI data show a further 3.4% increase in reinstatement costs since January, underlining the importance of working with current data.

To a certain extent, these increases are rooted in rising construction costs.

While materials cost growth has levelled off since the dramatic spikes recorded between 2020 and 2022, labour and plant costs have maintained strong upward trajectories.

For instance, according to the BCIS Labour Cost Index, which measures movement in labour costs and is based on nationally agreed wage awards and employment costs, the cost of labour in 2024 was more than one-fifth higher than in pre-pandemic 2019 and almost double the cost in 2004.

The shortfall in construction labour and high employment costs, alongside macroeconomic challenges like inflation, are big contributing factors and their presence will continue to drive up reinstatement costs.

While this certainly sparks the risk of underinsurance, delayed insurance renewals (which outdate cover as costs and inflation can rise quickly) and indexation inconsistencies are often the fuel that stoke the flames.

An Achilles’ heel

Indexation or index linking refers to the adjustment of buildings or property insurance cover by insurers to ensure the policy sum is accurate.

The risk of underinsurance, or indeed overinsurance, typically arises when the initial reinstatement value provided is inaccurate.

Property owners are not obliged to understand this value, and if it doesn’t account for macroeconomic and construction cost conditions in the first place, it will likely skew policy sums calculated by the insurer thereafter.

Further, geographical locations can be a contributor to both underinsurance and overinsurance.

In economically deprived areas where houses might be cheaper to buy but expensive to rebuild, underinsurance is more likely. This is because the cost of construction isn’t typically defined by the local economy.

Alternatively, in affluent areas, property market values can be much higher than the reinstatement cost and could lead to property owners paying far more insurance than is necessary if the original reinstatement value was inaccurate.

The extent of underinsurance and overinsurance among UK properties is a growing concern for risk-averse investors.

In cases where a property or portfolio is severely underinsured, insurers can cancel the policy under the ‘fair representation of risk principle’ – i.e. where the value of assets was underestimated or misrepresented, regardless of intent⁽¹⁾.

Further, under the ‘average clause’ principle, insurers are not required to cover the partial reinstatement of underinsured properties in full – just a proportion of the actual reinstatement cost equivalent to the percentage that is underinsured.

Take a property with a reinstatement cost of £500,000 as an example.

If the property is covered for 50% of this cost and sustains £100,000 of damage, the insurer is only required to pay £50,000.

The insurer still has the right to scrap the policy altogether if underinsurance is extreme enough.

Underinsurance is a nuanced challenge, but not one without an answer.

Meeting halfway

Under the Consumer Duty, insurers have a responsibility to know that the products and services provided to customers offer fair value and do not bring them harm⁽²⁾.

This means that, in the context of buildings insurance, insurers have some degree of duty to helping customers provide as accurate a reinstatement value as possible from the outset.

Assessing the risk of underinsurance or overinsurance attached to this value and recommending that a reinstatement cost assessment is undertaken to check its accuracy is standard practice.

The Financial Conduct Authority recently announced plans to strip back its insurance rulebook, a change that would no longer require insurers to review the value of their products at least every 12 months⁽³⁾.

Instead, insurers can use the risks and characteristics of products to determine review times. This affords greater flexibility but it’s still important that insurers continue to review the value of buildings insurance products with clients as a cautionary measure.

That said, the work cannot lie solely at insurers’ feet.

They are businesses with commercial interests and a higher level of input to tailor solutions will naturally lend itself to higher premiums.

This can lead to smaller insurers getting squeezed out of the commercial insurance market where they are unable to compete on pricing.

The answer ultimately lies in sharing the load.

Property owners must take some onus for their original reinstatement value and work with insurers to ensure cover reflects reality.

Using surveyors or professional reinstatement cost assessors who use BCIS to conduct valuations is best practice. BCIS data is routinely updated to account for changes in plant, materials and labour costs as well as macroeconomic and location factors.

Equally, regular valuations will inform accurate cover in the long-term; reinstatement costs can change quickly and particularly in response to economic shocks or severe sector challenges, such as sudden resource shortages.

Tackling underinsurance is no mean feat but with credible data and a collaborative approach to managing risk, the national picture can be improved.

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^{(1) AXA – Understanding underinsurance – here}

^{(2) FCA – Finalised Guidance – FG22/5 Final non-Handbook Guidance for firms on the Consumer Duty – here}

^{(3) FCA – FCA strips back insurance rulebook – here}