In the first two instalments of this series, we outlined the rapid pace at which liability claims costs are increasing and the macroeconomic factors driving this claims inflation. The series provided case study examples that demonstrated how easily liability losses can breach primary limits, focusing firstly on the construction industry and then on personal injury claims.
The third and final article in this series examines the implications underinsurance can have on the brokers advising the affected insureds.
What is underinsurance and who is affected?
Put simply, underinsurance is when a policyholder has inadequate insurance cover for their needs. In the event of a claim, this could mean a claim amount exceeding the policy limit. This could result in a shortfall for the policyholder, potentially leading to a serious financial loss for the organisation.
Our examples in this series showed how underinsurance resulted in both contractors declaring bankruptcy. In such cases, it would be reasonable to expect scrutiny of the insured’s broker to determine whether they were negligent in their duty to provide adequate advice.
The threat of underinsurance is not only present in liability claims: other common areas of underinsurance are property and business interruption with two in five commercial properties and 44% of business interruption policyholders in the UK thought to be underinsured.
Some of the common reasons for underinsurance in commercial properties are:
- Out-of-date valuations: If a property has not been professionally valued for some time, the cost of reinstatement is likely to be out of date as the cost of labour, plant and materials has mushroomed in the last few years.
- Use of market value versus reinstatement costs: Another common oversight for business owners is to insure for the market value when the sum insured should be the rebuild cost. This has always been an issue with property insurance but one that has got worse as commercial property values are falling but reinstatement costs are rising.
- Guesswork: Have policyholders simply guessed the value of the property? This is not uncommon and it is highly likely that any policyholder taking this approach won’t have taken into account rising costs.
When it comes to business interruption (BI), rates of inflation, supply-chain problems, labour market shortages, rising building costs and insolvencies within the construction sector mean it can take longer than expected to re-instate a business premises. Many policyholders simply won’t have enough cover for that extended period of disruption.
What are the duties of an insurance broker when it comes to underinsurance?
It’s well understood that underinsurance can lead to serious financial loss, or even insolvency, for the insured. Our example of the coffee-machine repair company is a case in point. However, what gets overlooked is the potential impact on the broker.
If the broker had failed to advise its insured to obtain sufficient cover – whether through a higher primary liability limit or additional layers such as excess of loss – it potential faces a negligence claim for its client’s underinsurance. In this specific example, the value of that claim could be up to £10m.
When it comes to first party property claims, it’s important to keep in mind that brokers have a duty to look beyond insureds’ instructions and warn them when these instructions won’t deliver the coverage they actually need. A recent court case serves as a cautionary tale in this regard.
An insured suffered a fire and discovered it was underinsured for BI so they brought a claim against their broker. The court found against the broker, awarding not only a sum equivalent to the shortfall in cover but also for the profit the insured would have earned if adequate cover had been in place in the first place. Significantly, the court found no contributory negligence on the part of the insured so placed the blame entirely on the broker.
Depending on the broker’s own errors and omission cover, a case like that could jeopardise its very survival. The reputational damage it would suffer is hard to put a price on.
Rising costs and resulting underinsurance is a threat to both insureds and brokers alike but one that can be mitigated with a proper understanding of an insured’s requirements. Diligent record-keeping of advice given and ultimate decisions taken is also important.
Our expert underwriters are always on hand to advise on the changing risk landscape, while our CNA Online excess of loss platform allows intermediaries to quickly and easily respond to shifts in levels of compensation payments and rising costs to ensure their clients are adequately covered.
About the Author – David Walsh
David is responsible for all professional indemnity and cyber claims for the UK and Continental Europe.
On joining CNA Hardy in 2020, David was initially a Senior Claims Technical Specialist focusing on professional indemnity claims. In 2021, he was promoted to Claims Manager for the UK and Continental Europe, and in 2023 his responsibilities were expanded to include cyber claims and UK regional claims.
David is a lawyer, qualified in England & Wales, having studied history at Cambridge University followed by the Graduate Diploma in Law and Legal Practice Course at BPP Law School. He completed his professional training with the law firm CMS in London, where he practiced for ten years as an insurance litigator.
The information contained in this document does not represent a complete analysis of the topics presented and is provided for information purposes only. It is not intended as legal advice and no responsibility can be accepted by CNA Hardy for any reliance placed upon it. Legal advice should always be obtained before applying any information to the particular circumstances. Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured. All products may not be available in all countries. CNA Hardy is a trading name of CNA Insurance Company Limited (“CICL”, company registration number 950) and/or Hardy (Underwriting Agencies) Limited (“HUAL”, company registration number 1264271) and/or CNA Services (UK) Limited (“CNASL”, company registration number 8836589) and/or CNA Hardy International Services Limited (“CHISL”, company registration number 9849484) and/or CNA Insurance Company (Europe) S.A., UK Branch (“CICE UK”, company registration number FC035780). CICL, HUAL and CICE UK are authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority (firm reference numbers 202777, 204843 and 822283 respectively). The above entities are all registered in England with their registered office at 20 Fenchurch Street, London, EC3M 3BY. VAT number 667557779.