Underinsurance: Why Conduct a Property Catastrophe Insurance Review
By Nick Gallo—
Property catastrophe insurance protects policyholders from damages from natural and man-made disasters, including losses from flooding, earthquakes, riots, and terrorist attacks.
Unfortunately, the frequency and severity of catastrophic events have risen in recent years due to several factors, like climate change and inflation. As a result, policyholders who don’t review their policies regularly can become underinsured against disasters.
Let’s further explore underinsurance, the risk it poses to business owners, and how agents can help their clients address the problem.
What is Underinsurance?
Underinsurance refers to having insufficient coverage for your risks. When underinsured policyholders suffer damages, their insurance payouts aren’t enough to cover their losses, and they must pay out of pocket to repair or replace their damaged assets.
Policyholders often find themselves underinsured because their claims exceed their policy limits. However, it can also occur when their policies have exclusions for certain risks, as is often the case with property insurance policies and catastrophic events.
Either way, underinsurance can cause significant financial hardship for business owners. For example, a restaurant owner's commercial property insurance policy has a $250,000 limit. When a hurricane strikes the area, it suffers $300,000 in property damages from wind and $25,000 in damages from flooding.
The insurance policy covers wind damages, but the restaurant owner is underinsured by $50,000 due to the policy’s limit. In addition, the policy doesn’t cover flood damages, so the owner is underinsured by another $25,000 due to the gap in their coverage.
Prevalence of Underinsurance
Your clients might not want to hear it, but underinsurance is a common problem. Policyholders become underinsured over time when they fail to review and update their coverage.
In the case of property insurance, the issue is often driven by rising materials and labor prices, which increase the cost of repairing or replacing damaged assets. Business owners often don’t update their policies and avoid doing so for fear of paying higher premiums.
The faster inflation occurs, the more quickly inattentive or reluctant business owners become underinsured. Unfortunately, the annual inflation rate has been well above the target of 2% in recent years.
In addition to rising construction costs, business owners may become underinsured due to increasing property values. Passive or forced appreciation causes their assets to be worth more, but they don’t update their policy. Therefore, they risk suffering losses that exceed their coverage limits.
Insurance agents must understand these factors and how they cause business owners to become underinsured, so they can educate clients on the dangers. Your clients may decide not to increase their coverage even after learning about the risks, but at least they'll make an informed decision.
Underinsurance Risks for Business Property Owners
Underinsured business owners face significant financial risk. If they suffer damages that exceed their policy limits or fall outside the scope of their policy’s coverage, they won’t be able to cover their losses by filing a claim. If they want to repair or replace their property, they must find other ways to cover the shortfall.
In the best-case scenario, owners would pay for the losses out of pocket. However, this method can significantly deplete or exhaust their cash reserves, which is often enough to cripple small businesses. In many cases, businesses go under because they don’t have enough cash to cover their damages.
They may be able to finance the expense by tapping into their credit. Unfortunately, even when businesses can pay their initial losses by taking on debt, the monthly payments reduce their cash flow. It may take longer, but that also causes many small business owners to fail.
In addition to the immediate financial strain from suffering such a significant expense, underinsured businesses often encounter secondary issues after experiencing uncovered property damages.
For example, the loss of critical equipment or an essential building can force a business to limit its operations or stop them altogether. As a result, business owners may experience a period where no revenues come in but expenses continue to mount.
Not only does that increase the financial strain on the business, but it can damage their relationships with clients and cause them to lose business or suffer lawsuits if they fail to deliver on contracted obligations.
Conducting a Property Catastrophe Insurance Review
Not only are catastrophic events becoming more frequent, but inflation is rising faster than usual. In current conditions, businesses should be especially vigilant against the risk of property becoming underinsured against natural disasters.
Unfortunately, business owners are often reluctant to increase their coverage if it means paying higher policy premiums. Insurance agents can help their business clients by taking responsibility for initiating the conversation.
When it’s time for your clients to renew their property policies, consider scheduling an annual insurance review. These meetings involve an in-depth discussion of their current coverage to make sure they're adequately insured.
During the review, explore the details of their current coverage, including any notable gaps or exclusions. If a client lives in a high-risk area for any specific disaster, point out the danger and suggest they consider purchasing catastrophe coverage through a rider or separate policy.
In addition, make sure to discuss whether each client’s policy is still adequate to repair or replace their property if it’s damaged in a covered incident. Compare their current property values to their policy limits and ask them about any improvements or additions that might increase their need for coverage.
Schedule Property Catastrophe Insurance Reviews
Conducting property catastrophe insurance reviews with your clients helps prevent them from becoming underinsured against natural disasters. Consider scheduling them once a year around renewals.