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The Importance of Understanding ‘Underinsurance’

Why do I need to know what Underinsurance is?

Underinsurance, which also known as the Average Clause or Co-Insurance sounds like another piece of Insurance jargon designed to confuse policy holders and protect Insurers. This is why it is very important not to ignore it, but to make sure you understand the consequences of not taking the time to choose correct sums insured for your assets.

In simple terms, Underinsurance is when the policy holder insures for less than the true value.

The importance of underinsurance

To ensure you obtain maximum protection from a policy you need to carefully check you have a sum insured that reflects the true and accurate replacement costs of your assets. Generally speaking, the higher the sum insured, the higher the premium and this can be a deterrent for many clients to put forward the actual sum insured when taking out a policy, hence the Underinsurance Clause is used by Insurers to penalise those clients that do not insure for the true amount.

It is not only about the value of the assets – in many cases where policies have additional benefits the Underinsurance Clause may hinder the amount that you are able to claim under other sections of your policy. Regardless of what amount your property was originally bought for and how much you think it is worth, the sum insured must either be equivalent to the current replacement value or the current market value depending on the type of policy you have. Your Insurance Broker will be able to explain what type of policy you have to assist you determine the basis for calculating correct sums insured.

How does Underinsurance work?

Usually if the sum insured is within 80% of the replacement value, most policies will allow this margin for error (as Insurers do not want to penalise those clients who have made a genuine attempt to select the correct sums insured) and the Co-Insurance Clause will not be taken into effect. However if the sum insured is below 80% of the correct value, Insurers will apply this clause and you will end up with a disappointing claims settlement.

What happens when you Underinsure your property?

By underinsuring your property, you place yourself in serious financial risk. You must regularly review the sums insured of your property. This is especially important if you change locations, expand locations or purchase new assets.

In many cases the penalty for underinsuring your property can be not in the tens of thousands, but may be in the hundreds of thousands and not many small businesses can survive a loss and such a shortfall – in fact, many small businesses are wiped out and never recover. Given the cost to prevent this happening, it should be an absolute priority to get your sums insured right.

An example of a client being effected by the Co-Insurance Clause would be:


Chosen Insured Value of Contents

Including carpets, computers, fit-out etc.


Actual REAL Value of Contents


Damage caused by fire


Underinsurance Penalty Calculation:
80% of Actual Real Value
Chosen Sum Insured x Damage:
Divided by 80% of Actual Real Value

$300,000 x $200,000 / $400,000

Claim Result
Out of Pocket Costs
Your additional loss

In this example, the Insured received $50,000 less, for not having the correct sum insured. That is a big difference.

A report by the Insurance Council of Australia in 2015 showed that while the number of small to medium businesses rate of “non-insurance” had fallen by over 10% in the last decade, only 2% of companies knew they were underinsured, with common reasons given being:

  • I cannot afford to pay for more insurance
  • Premiums are too high

Claims Assessors frequently report that following a large loss, those that have insured for the correct amount never complain about the premiums, however, by then, it is too late to change anything.

Do not take the risk – check you sums insured!

If you believe that this issue is relevant to your business, please feel free to contact Rebecca Fleming, Account Manager of our Travel Industry Division at Gow-Gates Insurance Brokers on (02) 8267 9919 or to discuss your circumstances or to obtain a quotation.

Gow-Gates Insurance Brokers advises that persons should not act on the material contained in this article as the items are of a general nature only and may be misinterpreted. We therefore recommend that advice be sought before acting in these areas.