Underinsurance often results in a business being unable to recover from a catastrophe. This often arises as a result of the insurance payout being insufficient for continuation of operations.
The coronavirus has impacted economies and lives around the world. Businesses have had to pivot their strategies, policies and offerings to stay in business. COVID-19 has created an environment where supply chains and established ways of working have been fundamentally changed.
Supply chain issues tend to multiply their impact on landlocked countries with a low manufacturing base such as Botswana, which relies on imports for most consumption. For instance, building material suppliers and contractors are reporting huge increases in costs over the last two years, more particularly in 2021.
Botswana imports both raw and finished goods from South Africa and China, and a massive part of its supply chain depends on the transportation sector worldwide. For example, the country gets most of its horticultural products, petroleum products, steel, wood and cement from these destinations. More recently, in 2021, Steel, bagged cement, wood and tiles were hit by supply shortages and increased demand after the easing of COVID-19 restrictions, leading to price increases between 25 percent to 40 percent.
Such price rises significantly impact smaller economies as inflationary pressures result in reduction in economic activity and governments constrained by their inability to rejuvenate the economy. Capital projects originally planned by corporates are shelved on account of the potentially large financial outlay expected for the projects. The cost of replacement assets skyrocket and historical costs become irrelevant. In such a scenario, businesses should be extra-vigilant to prevent underinsurance of their insurable assets.
What is underinsurance?
Underinsurance occurs when cover is set too low to adequately meet a policyholder’s needs. Below are some examples that demonstrate how underinsurance can affect diverse types of insurance cover.
Property – buildings sum insured
| Insured property value | Actual reinstatement value | Cost of repairs/rebuild following a loss | Claim settlement by insurer | Financial shortfall for policyholder |
| P7,500,000 | P10,000,000 | P5,000,000 | P3,750,000 | P1,250,000 |
| Estimated by policyholder using historical valuation report. Declared as buildings sum insured on policy. | True reinstatement value based upon professional valuation at the time of insurance effective date. Building only insured for 75 percent of its true value. | Policyholder suffers a major fire resulting in a partial loss (salvage examples are boundary wall, paving, part of professional fees, foundation etc). | Condition of average applies. Final settlement proportionally reduced to 75 percent of claim value. | Additional funds will need to be sourced in order to complete repairs to the building. |
Underinsurance risks often relate to replacement of buildings where the costs relate not only to the rebuilding of the building itself but also the consequential business interruption while the building is being replaced. Remember to think about:
- Costs for planning, permissions, site clearance, digging, construction, fit out – every step.
- The fact you will have to pay for alternative premises in the meantime.
- How long it will take for your turnover to recover once you have reopened.
- Lease, rent, rates and facilities outgoings still in your name.
- Insuring the property for the build costs, not the market value.
- Any extensions, changes or extra building work undertaken which could affect your sums insured.
- If you have rented a property, any tenants’ improvements you have made for which you are responsible.
Your business interruption insurance not only needs to cover your ongoing costs and net profit (even though you may not be trading due to the insured damage), but also should take into account the forecasting of how your profits and revenue are planned to rise during the period you are unable to trade. Therefore, while your business is recovering, your sum insured has to be adequate to cover future plans and growth as well.
In selecting your indemnity period, this must be of sufficient time to enable your turnover to recover to at least the same level as you were at the time the incident occurred. It is crucial to make sure you are adequately covered for all eventualities. It is also important to remember how long you will need the cover for, given all these factors.
Business interruption – maximum indemnity period
| Maximum indemnity period | Issues experienced during recovery | Period until full recovery | Claim settlement by insurer | Financial shortfall for policyholder |
| 12 months | Plus 6 months | 18 months | Cease at 12 months | Does not cover |
| Chosen by policy holder as maximum possible time to fully recover. Set as maximum indemnity period on policy. | Planning issues and winning back lost customers significantly lengthen anticipated recovery time. | Actual time taken for business to reinstate damaged property and return to its former profitability. | Business interruption claims payments cease after 12 months, before the business has fully recovered. | Unable to counteract reductions in revenue and the increased costs needed to successfully recover. |
Underinsurance principles can apply equally to all insured losses. It is therefore critical that the cover levels taken out at inception and renewal accurately reflect the risk.
