Accurate property insurance is critical for accommodation businesses, yet under-insurance remains a frequent and costly oversight. Regardless of what business you own in the accommodation sector, being underinsured can leave your business exposed to significant financial risk when a claim arises.
Under-insurance can have material financial consequences, leaving owners responsible for substantial shortfalls while trying to repair or rebuild their property. This article explores what under‑insurance means for accommodation providers, how insurers apply penalties, and real case studies showing the cost of getting it wrong.
What is Under-Insurance?
Under-insurance occurs when the insured value of a property is less than its true replacement or reinstatement cost. Many insurance policies include a provision – often referred to as an averaging clause or co-insurance clause – that allows insurers to reduce claim payments proportionally when a property is underinsured. If your insured sum is lower than the actual value, you share part of the risk when loss occurs.
Accommodation businesses will often have specialised fixtures, custom fitouts, compliance costs and complex structures, underestimating replacement value of this can be easy – but costly.
Why Under-Insurance Occurs
There are several reasons owners may under-insure:
- Decisions driven by cost: To reduce ongoing premiums, a lower insured sum is chosen, without accounting for the full replacement cost
- Outdated valuations: In current high-inflation environments, valuations may not be updated to reflect current construction-material costs
- Incomplete coverage assessment: Failing to include specialised items such as commercial kitchens, guest amenities, structural upgrades, and regulatory compliance costs.
- Market Value Assumption: insurance figures may be based on market value rather than replacement cost, which does not equate to the amount needed to rebuild after a total loss
How Insurers Apply Penalties
Most insurers will require the sum-insured figure to represent at least 80-90% of the replacement value. If the insured sum falls below this threshold, the insurer may apply the averaging or co-insurance clause. This reduces payouts proportionally based on the level of insurance.
For example: At time of a major claim, if a property is insured for $500,000 but the true replacement value is $1,000,000=the insurer may penalise you by only paying 50% of the eligible claim amount, leaving you to cover the balance.
Real Case Studies: Under-Insurance in Action
1. Hotel Fire Claim Reduced Under AFCA Ruling
In a determination by the Australian Financial Complaints Authority (AFCA), a hotel suffering fire damage sought full repair costs from its insurer. The building was insured for $1,000,000, but a professional quantity surveyor valued the replacement at approximately $2,896,006, nearly triple the insured amount.
Applying the under-insurance clause, the insured value was calculated against the true value, and the insurer’s liability was adjusted accordingly. After applying the clause, the insurer’s payout for reinstatement was reduced significantly, resulting in a much lower claim settlement than expected.
This is a stark demonstration of the financial risk associated with under-insurance, where despite being a legitimate claim, settlement can be affected if the property isn’t insured adequately against its true value
2. Commercial Property Under-Insured for Storm Damage
Recently, a commercial property affected by significant storm damage has also resulted in a case of underinsurance. The property was insured for $1,000,000, but the replacement figure was reassessed post-claim and valued at $4,460,000, and additionally, the storm-damage repair costs totalled $439,500. As a result, the sum insured only represented approx. 25% of the actual value and hence, the insurer applied the co-insurance clause. In this case, the insurer’s payout was reduced to just $123,178, leaving the owner with a shortfall of more than $316,000 to cover themselves.
This demonstrates that even for partial losses, being under-insured can still leave business owners responsible for large out-of-pocket costs.
Practical Impacts on Accommodation Businesses
The impact of under-insurance can progress to broader operational and financial issues, in addition to affecting rebuild costs:
- Delayed Reopening: receiving a lower payout can delay repairs and impede a smooth recommencement of trading, in turn affecting revenue and reputation
- Cash Flow Strain: Out-of-pocket expenses to counterbalance low payouts impact working capital and reduces investment in operations or upgrades.
- Borrowing Costs: Owners may need to secure loans to cover shortfalls, adding interest and financial risk
- Regulatory Compliance Costs: If evolving building codes are not included in a policy, the cost to meet compliance during rebuilds may not be covered.
Best Practices to Avoid Under-Insurance
1. Engage Regular Professional Valuations
Replacement costs change over time. Engaging qualified professionals to valuate your building regularly will ensure the replacement value aligns with construction costs, compliance requirements and the general cost of reinstatement.
2. Include All Relevant Costs
Ensure your policy covers all necessary costs, including but not limited to; structural rebuilds, fixtures, fitouts, compliance upgrades, demolition and debris removal, and specialised installations.
3. Annual Policy Reviews
Review your cover annually, especially following any renovations, expansions, or market shifts, like rising construction costs.
4. Document and Inventory Assets
Accurate records support valuations and claims, so it is important to maintain detailed inventories of property, equipment, and contents.
5. Work with Specialists
Brokers experienced in accommodation and commercial property insurance can help tailor your coverage, explain policy terms, and highlight under-insured risks.
Final Thoughts
Under-insurance is a common but serious risk for accommodation businesses. Failing to insure a property for its replacement cost can lead to reduced claim payouts, significant financial exposure, and operational disruption.
Real case studies show why accurate, up-to-date valuations and thorough coverage is required. Protect your assets and business continuity by seeking advice from insurance specialists to ensure coverage is comprehensive and accurately reflects the replacement value of your property.
Don’t wait until a claim reveals gaps in your coverage – contact our specialists today to request a comprehensive review of your policies. We can help to ensure your property is protected against the financial impacts of under-insurance.
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