Risk of underinsurance mounts for SMEs

Running a business can be a juggling act at the best of times. In recent years, SMEs have had even more to deal with – from a global pandemic that touched practically all aspects of doing business from staffing to supply chains, to a spate of natural disasters and tumultuous economic conditions with high inflation, rising interest rates, declining property values, labour shortages…the list goes on.

These factors are coming together to fuel an ‘underinsurance trap’ – where business owners are either intentionally reducing coverage to cut costs or inadvertently finding themselves underinsured by failing to recognise all the risks their business faces, underestimating replacement or repair costs, or the cost of liabilities, or not fully understanding their insurance policies.

Underinsurance happens when an owner does not have enough insurance to cover the cost of loss or damage to their business, or their legal liabilities, when something goes wrong (insured event). When business owners find themselves underinsured, they’re often exposed to financial hardship or inadequate cash flow when misfortune or disaster strikes. It’s been estimated that two-thirds of Australian businesses are underinsured (Business Australia) and that a quarter of SMEs have no form of general insurance at all (Insurance Council of Australia).

According to Vero’s 2022 SME Insurance Index, 57% of firms don’t believe they are completely covered for insurable business risks, while 34% have no plan if something bad were to happen, and one in five suggest they would have to cease operations if they suffered a major negative event.

For some business owners, the need to look at ways of cutting costs has led to underinsurance. Vero’s report suggests that SMEs with declining revenue are less likely to say that they are completely covered and are also less likely to have a plan in place for a negative event. However, the dangers of underinsurance can leave the policyholder in an even worse situation. Not only could the business owner be left seriously out-of-pocket, but they could trigger an underinsurance clause in their policy. These clauses are designed to discourage businesses from purposely undervaluing their assets and are triggered when underinsuring assets by 20% or more (generally). It means that insurers are entitled to pro-rata any payout.

Other SMEs fall into the underinsurance trap by accident.

A primary reason for this is underestimating the value of assets and nominating inadequate sums insured. Still others find that they are not covered for a negative event because they never considered that they were at risk and failed to insure against it. A prime example is cyber insurance. Some policyholders also find they are not adequately insured as they have not understood their policy, for example they are not aware of restrictive terms or exclusions.

Whatever the reason, the result is the same – the owner thinks they are insured properly or well enough, only to find that they are not (usually at claim time).

According to industry sources, the main areas where businesses find themselves underinsured are:

  • business interruption
  • property coverage
  • injury or damage to others or their property (public liability)
  • faulty workmanship/product (professional liability and product liability), and
  • sums insured for business assets.

Tips to avoid underinsurance:

Assess your risks
Be sure to take into consideration the specific risks your business faces and ensure that the critical factors to operate are covered. Take all types of risk into account including legal, financial, operational and environmental. Establish a risk assessment process that is continually reviewed and updated regularly to ensure you are across the changing risk environment.

Understand your covers
It is imperative that you understand what your insurance policy covers, under what circumstances, and the limits of the cover – the terms of the policy. Just as important is knowing what isn’t covered, any restrictive terms and exclusions. Always clarify with your broker if you are not certain about coverage or conditions before committing to initiating or renewing a policy.

Review your policies frequently
Don’t set and forget. It is important to periodically review your policies to ensure they are still providing the cover that you need to protect against evolving risks. Be sure to consider whether there have been any changes to the business or the way it operates including upgraded equipment, systems or processes; expanding stock or premises; new equipment and other business assets; changes to turnover; taking on major new clients or contracts; new products or services; changes to sales channels, distributors or trade partners; changes to the business structure such as newly created entities or changes to directorship or ownership; and employee matters (number, type e.g. contractors, locations e.g. working from home etc.). Even if your business hasn’t changed, chances are the environment in which it operates will have.

Value your business and its assets correctly
Insure your business for an amount that is sufficient to cover not only the tangible assets, but the cost of repairs and any other variables that might leave you out-of-pocket. Thanks to inflation and supply chain issues, repair and replacement costs are increasing exponentially. Be sure to get accurate valuations for property including premises, building contents, plant, equipment, machinery, vehicles and stock. Don’t forget to take into account factors such as exchange rates and inflation. It is also important to accurately calculate expenses for business interruption policies, ensuring there is an adequate indemnity period and including increased costs of working in the interim (e.g. renting alternative premises and equipment).

It can be difficult to identify and assess the specific risks your business faces, which is why your EBM Account Manager is here to help. We’ll work with you to build an insurance program that integrates different types of cover to protect your business from a range of risks – and be there when it is time to review your package to make sure you stay well protected.