The creeping risks of underinsurance

If your business insurance premium hasn’t increased over the last 18 months, then you can count yourself among a very small minority. The combination of an increased number of claims, the increased cost of doing business and a lower ROI has led to capacity constraints among insurers. As a result, some insurers have even stopped writing certain classes of business, such as directors and officers and cyber insurance.

Day-to-day, this has resulted in a tightening of underwriting appetite (including higher risk mitigation requirements for customers), a significant increase in premiums and, more often than not, a reduction in the amount of insurance, or ‘limits’, available for businesses, leaving them underinsured.

The tangible risks of being underinsured

Breach of contract

For many businesses, the first time you may consider purchasing insurance (aside from statutory requirements) is when you are faced with a contractual requirement to do so. This could be when working with another business, as part of a regulatory requirement, or as a condition of any private funding or capital raise.

When it comes to contractual requirements for insurance, North American contracts tend to be much stricter and require more insurance than their European counterparts, but the gap is certainly closing. We have seen a wider adoption of contractual requirements in particular for cyber insurance, directors' and officers' insurance and professional indemnity across the UK and Europe over the past few years.

Often these insurance requirements under contract are for specific, fixed amounts, and don’t always relate to the size of the business or value of the contract. Indeed, we have seen contractual requirements for limits in excess of £10m in the UK, and in excess of $25m in the US.

With insurance limits being harder and more expensive to obtain, there is a risk of businesses inadvertently breaching these contractual requirements. Alternatively, there is a high chance of having to pay more just to satisfy the contracts, potentially leading to businesses questioning the viability of the contract in the first place.

As we witness the hardening of the insurance market, not just in the UK, but worldwide, we have found the (re)negotiation of these sorts of contractual requirements to be quite common, even mid-term during the life of the contract. Our advice is to start any re-negotiation as early as possible.

Whatever your specific situation, it’s important that the ‘insurance buyer’ in your company is actively aware of the commercial stipulations of the type and amount of insurance required under contract, to avoid any potential contract breaches.

Forced change to risk tolerance

Insurance is, at its heart, a form of risk transfer. While there is almost always an element of self-insurance on every policy (excesses, deductibles, retentions, etc.), generally speaking paying an insurance premium allows your business to transfer financial risk away from a balance sheet, freeing up funds for capital expenditure, investments and fuelling growth.

Some more risk-averse businesses will, alongside their broker, carefully calculate and quantify their risk profile; both in terms of claim frequency and severity. These businesses will generally purchase higher insurance limits to transfer as much risk as they possibly can to their insurers.

In hard market conditions, however, these higher limits simply aren’t as readily available as they once were. If these higher limits somehow are available, the premiums to transfer all of this risk to insurers have increased significantly. Businesses are being forced to re-evaluate their risk profile and tolerance; often being unable to obtain or afford the limits they once wanted. This can have a meaningful impact on their ability to free up funds for other expenses and investments.

Not having enough cover to pay a claim

If you are unable to buy enough insurance (due to cost or market availability), then there is certainly a risk that any claim that you suffer might exceed the amount of insurance you have in place.

To better understand how much insurance you actually have, it’s worth being aware of two things:

1. The insurance limits you have in place for each and every claim
2. The annual aggregate limit (if it applies); i.e. the total insurance cover you have in any one-year period

Both of these factors, when looked at alongside your risk profile, play an important part in understanding your risk tolerance and your ability to cover claims.

Countering under-insurance through risk mitigation

Any good insurance advisor can help you understand how much insurance you need, and explain the specific risks to your business of being under-insured. Sadly, however, being underinsured to a greater or lesser extent is a likely reality for most businesses under current market conditions.

As well as working through your business’ risk profile, it is also important to re-evaluate whether your risk mitigation investment is appropriate. You may wish to consider whether you have invested enough into policies, processes and other risk mitigation tools to prevent the likelihood of having to make a claim in the first place.

We’re here to help

While we aren’t out of this hard market cycle just yet, there are glimmers of hope in certain pockets. We have very strong relationships with underwriters across the insurance market and are well positioned to help customers re-engage with higher limits, as and when the market begins to soften.