Underinsurance and the average clause: the quiet claim-killer
What the average clause actually does
The logic runs like this. Premiums are calculated on the values you declare. If you declare less than the full value at risk, you have — knowingly or not — paid a premium for only part of the risk, and the average condition treats you as your own insurer for the remainder. In a claim, the payment is reduced pro rata: the sum insured divided by the true value, applied to the loss.
The part that catches people out is that average bites on partial losses — which is to say, on almost all losses. Businesses often reason that a total loss is vanishingly unlikely, so a lower sum insured is a sensible economy. But the reduction applies to the everyday fire, flood or theft claim too, long before the sum insured itself is exhausted.
A worked example (illustration only)
The figures below are round numbers chosen to show the arithmetic — a generic illustration, not a quotation and not any real claim.
Suppose a building’s true rebuild cost is £1,000,000, but the sum insured on the policy is £600,000 — 60 per cent of the true value. A fire causes £100,000 of damage. Under a pro-rata condition of average, the claim is scaled in the same proportion:
£100,000 loss × (£600,000 sum insured ÷ £1,000,000 true value) = £60,000 payable (before any excess). The remaining £40,000 falls on the business — even though the loss was well within the sum insured.
Note what did the damage here: not the fire, but the gap between the declared value and the true one. Policy wordings differ — some apply average only when the shortfall exceeds a stated margin, and the precise mechanism varies — but the principle is standard across most commercial property, contents and stock covers.
Why values drift below reality
Inflation, and gaps in index-linking
Rebuild costs move with materials and labour, and in recent years they have moved a long way. Index-linking helps, but only if the starting figure was right and the index reflects construction costs for your kind of building; a correct figure from years ago, casually rolled forward, can quietly fall behind.
Rebuild cost versus market value
The classic error: insuring a building for what it would sell for, when the policy basis is the cost of rebuilding it — demolition, site clearance, professional fees, and current building regulations included. Market value and rebuild cost can differ dramatically in both directions, and neither is a substitute for the other.
The business changed and the schedule didn’t
New machinery, higher stock levels, an extension, a mezzanine, better specification — values at risk rise as businesses grow, and sums insured only rise when someone tells the insurer. The same drift affects business interruption sums insured, where growth in turnover and margin can leave the declared gross profit figure well behind the real one.
Reinstatement, day-one uplift, and other basics
Most commercial property insurance is written on a reinstatement basis — new for old: the sum insured needs to reflect the full cost of rebuilding or replacing as new, not the depreciated value of what you have. Day-one uplift (day-one reinstatement) is a common refinement worth understanding: you declare the accurate rebuild cost at the start of the policy year — the day-one value — and the policy builds in an uplift percentage on top to absorb inflation during the year and the rebuild period that would follow a major loss. It is protection against inflation after the declared figure was set; it is not a licence to declare a low figure, because the declared value itself still needs to be right. Where cover is written on an indemnity basis instead, wear and tear is deducted — another reason to know which basis your policy uses before assuming what a claim would pay.
How to fix it at renewal
Underinsurance is unusually cheap to fix, because the fix is information. At renewal: get a professional reinstatement cost assessment for buildings — typically a modest cost against the exposure, and worth refreshing periodically rather than never; rebuild the plant and contents figures from the asset register at current replacement cost, not book value; set stock figures at realistic peak levels, or use seasonal or declaration-linked arrangements if stock swings; and recalculate BI figures on the policy’s definitions with your accountant. Then tell your insurer about changes as they happen during the year, not twelve months later. A broker’s renewal job is largely this: making sure the numbers underneath the policy would survive contact with a claim — and if a claim has already exposed a shortfall, presenting it well at the next renewal matters all the more.
Frequently asked questions
Does average only matter if my building burns down completely?
No — the opposite. Average applies to partial losses, which are the overwhelming majority of claims. A modest fire or flood claim can be scaled down for underinsurance long before the sum insured is anywhere near exhausted.
Is underinsurance the same as having a claim rejected?
Not quite. Average reduces the payment proportionately rather than refusing the claim — though severe underinsurance can raise wider issues, and the practical effect of a heavily scaled claim can feel much the same. If you think a reduction has been misapplied, our page on challenging claim decisions covers the route.
Should I insure my building for its market value?
No. The right figure for a reinstatement policy is the full rebuild cost — including demolition, site clearance, professional fees and compliance with current regulations — which can be far from market value in either direction. A reinstatement cost assessment answers the question properly.
What is day-one uplift for, in one sentence?
It protects an accurate day-one rebuild figure against inflation during the policy year and the rebuild period after a loss — it does not repair an inaccurate one.
How often should rebuild costs be professionally assessed?
There’s no single rule, but periodic professional reassessment — rather than indefinite index-linking of an old figure — is the prudent pattern, and sooner if the building has been altered, extended or repurposed. Ask us what makes sense for your property.
Does underinsurance affect business interruption cover too?
Yes. BI sums insured drift for the same reasons — growth, inflation, and gross profit calculated on the accountant’s definition rather than the policy’s — and BI sections commonly carry their own underinsurance provisions. Declaration-linked BI cover exists largely to soften this problem; our BI guide explains it.
Apex Insurance Brokers Limited is authorised and regulated by the Financial Conduct Authority (FRN 724952). This page is general information, not advice on a specific policy.