It's tempting to reduce insurance costs by lowering coverage limits or increasing deductibles. But underinsurance carries hidden costs that can far exceed any premium savings.
What is underinsurance?
Underinsurance occurs when your coverage limits are less than the actual value of your assets or potential liabilities. It can happen in several ways:
- Building undervaluation - Insuring a building for less than its replacement cost
- Inadequate liability limits - Coverage that won't fully protect against a major claim
- Missing coverage types - Gaps in protection for specific risks
The coinsurance trap
Most commercial property policies include a coinsurance clause, typically requiring you to insure your building for at least 80% of its replacement value.
Here's where it gets dangerous: if you're underinsured and file a claim, the penalty isn't just the coverage gap. The coinsurance formula can reduce your payout significantly.
Example
- Building replacement cost: $10 million
- Coverage purchased: $6 million (60% of value)
- Coinsurance requirement: 80%
- Loss amount: $500,000
Expected payout: $500,000 Actual payout: $375,000 (75% of loss)
You'd be responsible for $125,000 out of pocket—on top of any deductible.
Beyond property: liability risks
Underinsurance on liability coverage can be even more devastating. A single serious injury claim can exceed $1 million. If your limits are $500,000, you're personally responsible for the rest.
How to protect yourself
- Get current valuations - Update building values annually using construction cost indices
- Review limits regularly - As your portfolio grows, your coverage should too
- Work with specialists - General brokers may not understand property-specific risks
- Base coverage on actual exposure - Use accurate valuations and risk assessments, not arbitrary limits
Taking these steps ensures you're truly protected when it matters most.
