Under-insurance – what it is and how it could cost you a packet
Under-insurance is one of the most commonly misunderstood aspects of home insurance.
But many insurance companies will use it to avoid paying out in full on a claim, even refuse a claim in full.
And, even though the Financial Ombudsman Service takes a fairly strict line on the matter, carefully worded insurance application forms and clauses often mean they will have to back the insurer in any dispute.
It’s best then, all round, to understand what under-insurance is, how it could affect you, and then avoid it.
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In this guide we tackle under-insurance; our little menu below will help you navigate to the section you're interested in.
What is under-insurance?
What to look out for
What if answers are all filled in for you?
What about inflation?
What if you just make a mistake?
What is under-insurance?
As its name suggests, under-insurance is where you insure a risk, but for less than it would cost for you to return things to normal.
You insure your house for rebuilding purposes for a total of £300,000, say, when in fact the rebuild cost would be £500,000.
Many people may take the view that the risk of their home being completely destroyed is slight, so they are prepared to risk only getting three-fifths of the cost of a total rebuild.
But it doesn’t stop there.
Under-insurance such as this can allow an insurer to apply what is known in the industry as ‘averaging’.
This means that if you insure your total loss for, say, 20% less than it’s true worth, ANY claim you make could be paid out with 20% taken off.
This is what catches a lot of people out.
If you insure ALL your contents at a total replacement value of £30,000 and the insurer decides it should have been £40,000, and you later make a claim for £200 on an item, they may only pay out £150.
What to look out for …
It’s therefore best to be very careful when you answer questions on an insurance application form, and pay special attention to the way the questions are worded.
This is because, in the event of a dispute, the wording of questions and how you answer is really going to matter to the financial ombudsman.
Average clauses - where the small print says the insurer will apply averaging in the event on under-insurance – are very common in home insurance policies, but by no means do all have them.
However, the ombudsman says it is not unheard of for insurers to try and apply averaging even when there’s no clause in a policy.
If that happens, they take a pretty dim view and you’d probably win any complaint.
However, where there IS such a clause, things get a bit more complicated.
The way you are asked the question about total value becomes vital.
When applying for contents insurance, you’re likely to be asked questions such as:
“What is the total value of contents held at your property?” Or, “How much cover do you require?” or, “What sum insured do you require?”
These can be answered in very different ways.
One is asking about the total value of items in the property, while the other two are asking what amount the applicant wants to insure.
For an insurer to apply averaging (even if they do have a clause in their policy about it), they would have to ask about ‘total value’ in this question, the ombudsman says.
Here’s what it says on the matter in full: “If an insurer did not ask the consumer to state the replacement cost of their entire contents, we are unlikely to agree that it is fair to apply the average clause on the basis that the consumer did not disclose this amount.
“Neither would we think it fair for the insurer to use either misrepresentation or non-disclosure as a reason to avoid the policy or reduce the claim payment.”
Exactly the same principle applies to buildings insurance. However, under-insurance and averaging being applied here could lead to a truly massive shortfall.
So, again, caution is necessary.
One of the main problems can revolve around a normal policy holder being expected to know the cost of totally rebuilding their home.
With buildings insurance, again, there are various ways the question about value can be asked.
“Amount to be insured…”, or the far more comprehensive, “buildings - value - the value shown should be the present day rebuilding cost including debris removal, architects’, surveyors’, consultants’, legal fees and VAT and the additional cost of complying with government or local authority requirements.”
The ombudsman says it will look carefully at the way the question was asked and how much assistance is given to the applicant to reach an accurate answer.
When deciding cases, it says it will look at two specifics in particular:
2. Does it state what has to be included in the rebuild cost?
The ombudsman also looks at other key questions, which all add an extra layer of protection to the consumer in the event they find themselves in dispute with an insurer.
It will ask:
* Were clear descriptions provided to help the consumer value their contents or estimate the property’s rebuilding cost?
* Was it made clear that the insurer was seeking the full replacement cost of the contents in the property?
* Was it made clear what the insurer meant by "contents" – for example, was it clear (if it is the case) that these included all personal possessions even if these were separately insured under "cover away from the home"?
* If the application was made online, would the consumer have been unable to complete the application without reading any guidance notes (if these were available)?
If the answer to any of these questions in the ombudsman’s opinion is ‘no’, it is unlikely they would consider it fair for an insurer to apply averaging.
What if answers are filled in for you?
Applicants need to be careful not only when assessing the total sum insured, they need to be wary of online forms that automatically fill in amounts based on the answers they give to earlier questions.
Application forms will often make a calculation based on answers to questions such as, “How many bedrooms does the property have?”
In this case, the ombudsman says that, so long as the applicant has been advised they should check all pre-filled parts of the form to make sure they are accurate, it would be likely to back an insurer who applied averaging if there was under-insurance.
So, the key here is NOT to rely on those pre-filled figures being accurate. Examine them carefully.
What about inflation?
We never advise people to stick with the same insurer for year after year as this is usually a root to overpayment (make sure you compare prices regularly to avoid paying too much).
But, what if you do end up staying with the same insurer and your total sum insured isn’t adjusted over the years?
This way you could easily end up under-insured, even when you weren’t when you took the policy out in the first place.
Under many policies, the sum insured is index-linked, so protecting the consumer, so long as they got the figure right in the first place.
But we’d advise a recalculation every couple of years or certainly checking with the insurer whether they have factored in inflation.
What if you just make a mistake?
If you don’t take reasonable care to provide an accurate total insured figure and the insurer has made it very clear they want want one, AND the insurance policy does have an averaging clause, then you are unlikely to win an appeal.
In fact, the ombudsman warns that it is likely to support the insurer in applying averaging even if there was no clause about this in the policy – IF the applicant is shown to have carelessly misrepresented the total insured.
Unsurprisingly, if the ombudsman finds the claimant deliberately misrepresented the sum insured, it says it is ‘very likely’ to back the insurer deciding to reduce the payout proportionately.
The Financial Ombudsman Service runs a help desk for further advice on this subject.