Up to 40% of small businesses are underinsured, according to the FCA. Now Allianz says it will remove the average clause from SME policies. Will other insurers follow suit?

flooded shops

It’s a nightmare scenario for any business: suffering a catastrophic property loss through fire, flood or storm damage, putting in a claim and then discovering that they are underinsured.

To make matters worse, claimants often find that the insurer will then offer them much less than the amount they are covered for.

It can be a confusing and frustrating time for the underinsured. The reason is that many commercial property policies include a condition of average clause that kicks in if a property is underinsured.

Insurers are then able to apply ‘average’ to the settlement of the claim, effectively reducing the payment made by the percentage of underinsurance.

“If there’s an average condition in the policy, if you find yourself underinsured by 50% the claims payment will be reduced by 50%,” says Allianz SME markets director David Martin.

In January, Allianz announced it was scrapping the average clause for SME customers, on the back of the findings of the FCA’s thematic review into SME claims, says Martin. 

Mind the gap

The review found that up to 40% of SMEs could be underinsured. It also highlighted the gap between SME expectations and the actual service these insureds were receiving, with some customers feeling they had not been treated fairly.

In particular, the FCA identified a significant number of cases where sums insured were inadequate to cover the loss incurred. For Allianz, the decision to scrap the average clause was a natural conclusion, with the insurer taking “a fundamental cultural position to protect customer outcomes”, according to Martin.

“We looked at it in detail in terms of the impact to us, in making sure the client proposition was sustainable,” he says. 

“We’ve done a lot of technology work to ensure that it is and we’re able to stand out in the SME market as the insurance carrier that is protecting SMEs in the event of innocent misrepresentation of the sum insured.”

Weather test

From pubs and shops to bed and breakfasts and curry houses, numerous small businesses across the North West of England, Scotland and Yorkshire were affected by last winter’s storms and floods. 

Research by the Federation of Small Businesses (FSB) found that two-thirds of small businesses have been negatively affected by severe weather in the last three years, costing them an average of just under £7,000.

It is in their hour of need, when properties have been damaged by extreme weather, that SMEs often get their first taste of how their property insurance policy will respond.

And if they have failed to take out adequate protection they are likely to find their insurer will not pay out in full or worse; in cases of deliberate underinsurance, claims can be repudiated. For many small businesses this is enough to put them out of business.

“Insurance can be a lifeline for businesses,” says Marsh risk and property practice leader Europe, Middle East and Africa Caroline Woolley. 

“Not many businesses operate with lots of stock and cash, so if something happens there needs to be funds available to assist almost straightaway. 

“Definitely for a smaller business it is vital to have that lifeline via insurance funds after a major loss to make sure the business can continue to operate and get back up and running as quickly as possible.”

Underinsurance in commercial property is frequently caused by giving an insurer an incorrect sum insured. 

There is often confusion between building sum insured – the cost of rebuilding a property – versus its market value – the price paid to buy it. 

Higos head of commercial lines Chris Wilde says: “You can buy a building at a reasonable cost, but it could be 200-year-old building with six foot walls that will cost a fortune to rebuild. And if it’s listed, that brings in additional complications.”

 Other sources of underinsurance can stem from infrequent valuations that allow the surveyor to factor in issues affecting rebuild costs including inflation, legislative changes and building alterations. 

Small businesses should check their policies include the removal of debris, cover that is included in most – but not all – commercial property insurance policies.

Duty to advise

Big Data and analytics have an important role to play if more insurers are to follow Allianz’s lead and scrap the average clause, Martin believes. 

With the increasing granularity of catastrophe models and the ability to generate information about a property at a postcode level, insurers have numerous tools with which they can assess both risk and sum insured. 

Brokers also have a key role to play in ensuring small businesses have adequate protection and calculate the correct sum insured. 

This duty is enshrined within the Insurance Act, which will become law in August this year, and puts the onus on brokers to make sure customers are fully advised if they are under-insured. It will also require intermediaries to alert insurers to possible instances of underinsurance.

Given the increasing number of SMEs – particularly micro-businesses – going online or buying their insurance direct, there is concern, however, that some small business customers may fall through the net. 

“I’m a firm believer in whether you’re paying £500 in premium a year or £500,000, it’s still the same expert advice you require,” says Wilde. “It’s about the customer experience and whatever size the business, they need that expert advice.”