Why Is It So Important to Get Your Sum Insured Correct?
Every commercial property insurance policy includes an Average Condition (the underinsurance clause) that penalizes policyholders when a claim is made. Understanding and correctly calculating your sum insured helps minimize the likelihood of penalties under this clause.
While higher sums insured result in higher premiums, underinsuring your property may expose you to significant financial loss.
As your advisors, we aim to clarify the potential implications of underinsurance so you can make an informed decision about your coverage.
The Average Condition in Action
A Simple Example
1. Your Building’s Replacement Cost: $5 million.
2. Your Insured Amount: $3 million (60% of the replacement cost).
3. A Fire Occurs: Repairs cost $2 million.
At first, you might assume your $3 million policy covers the entire claim. However, the Average Condition means you have insured only 60% of the risk, so you are responsible for the remaining 40%.
Claim Settlement
-
Insurer pays 60% of the loss: $1.2 million. -
You cover the remaining 40%: $800k.
This unexpected shortfall can be financially devastating. The only way to avoid this is to insure your property for its total replacement value, including allowances for inflation, debris removal, and professional fees and VAT if applicable.
Avoiding the Average Condition Penalty
Ensuring that your sum insured reflects your property’s true replacement value reduces the risk of penalties under the Average Condition. We can also explore strategies to build flexibility into your policy to protect your business better.
Remember: Large losses may be rare, but when they happen, being adequately insured can save your business.
The Impact of Deductibles and the Average Clause
Why Separating Building Values Matters
Deductibles for hurricanes, earthquakes, and floods are calculated as 2%–5% of the sum insured, not the claim amount.
We recommend breaking out the sum insured to individual buildings/structures so that the catastrophe deductible applies to that building/structure rather than the full sum insured. However, when the sum insured for a building is less than its replacement value, the Average Clause still applies, reducing the payout proportionally.
For example, if you insure a building for only 70% of its value, you will be treated as a co-insurer for the remaining 30%, and any claim will reflect this shortfall.
We recommend that Contents and stock are not split across buildings because their mobility makes precise allocation difficult.
Properly addressing deductibles and the Average Clause ensures better financial protection in a disaster, particularly when only part of your property is affected.
Setting Up Your Property Insurance Schedule
The Tomlin Insurance Brokers’ Approach
To ensure comprehensive coverage while avoiding unnecessary complications, we aim to balance detail and simplicity in your insurance property schedule.
We take an inclusive approach, combining uplifts into a single insured value. This method offers flexibility during claims negotiations, avoiding itemized coverage constraints while ensuring you are adequately protected.
Insurers require accurate and relevant information about the risk to underwrite a policy properly. However, overly detailed schedules need constant updates, which can jeopardize your coverage if they are not kept current.
After years of handling large claims, we’ve developed an approach that provides inclusive descriptions while remaining practical for most clients. Here’s our recommended structure:
Property Insurance Schedule Layout
1. Buildings & Fixed Structures: All buildings and permanent fixtures.
2. Contents: Machinery, equipment, furniture, fixtures, and fittings.
3. Stock in Trade or Inventory: Goods held for business operations.
4. Special Items: Infrastructure across the site, High-risk or unique items such as piers, jetties, and landscaping, which insurers may hesitate to cover.
Determining the Correct Sums Insured for Your Commercial Property
To avoid underinsurance and penalties under the Average Clause, each category of your property must be insured at an appropriate value. This involves calculating a Core Value and applying necessary uplifts for additional costs and coverage extensions.
Category 1: Buildings
Core Value
The core value is the replacement cost of your building with materials equivalent to the original structure. This value should come from a qualified Quantity Surveyor rather than a bank or real estate valuation, which focuses on market value, not replacement cost.
Uplifts
Professional Fees
Uplift by up to 15% to cover architects, engineers, and other professionals required for reinstatement.
Debris Removal and Demolition
Uplift by up to 5% to cover these significant post-loss costs.
Non Discretionary Uplifts
VAT
If your business operates in a country with VAT, you must uplift your core value by the VAT rate to avoid underinsurance. When a claim is settled, the insurer deducts VAT and pays it to the tax office. You receive a receipt, allowing you to offset this amount against the VAT incurred during reinstatement. While the process is cash-neutral, failing to include VAT in your sum insured will result in underinsurance and reduced claim payouts.
Claims Stamp Duties or Taxes
Account for any government-mandated deductions, such as the 1% tax in Barbados.
Category 2: Contents
Core Value
Insure all machinery, plant, furniture, fittings, and leasehold improvements at their replacement value new.
Uplifts
Similar to buildings, apply uplifts for professional fees, VAT, and other relevant extensions.
Category 3: Stock 
Core Value
Insure stock at cost price, not selling price, and analyze different manufacturing stages if applicable.
If you have Frozen Stock, please provide us with a separate value for this item.
Uplifts
As with buildings and contents, include necessary uplifts to cover extensions and regulatory costs.
Category 4: Special Items and General infrastructure
Special items, such as General Infrastructure, piers, jetties, and landscaping, must be itemized and carefully defined. We recommend discussing these details directly to ensure proper valuation and coverage.