Underinsurance - a risk for both insurers and SMEs

February 4, 2020
Underinsurance - a risk for both insurers and SMEs

Insurance: it’s one of those things you hope you will never need, but you can’t operate without. When things go wrong, there’s nothing more reassuring than knowing your business is covered.

Yet many small and medium enterprises (SMEs) are unwittingly underinsured. Research from the Financial Conduct Authority, the UK’s financial regulator, found multiple instances where British SMEs were not adequately insured against the plethora of risks and liabilities they face.

Worryingly, more than a quarter (28%) of UK SMEs say their businesses would collapse if they were faced with a bill of £50,000 or more, research from insurance group RSA shows.

This makes for worrying reading given that not having enough insurance can prove disastrous: from employee redundancies and the loss of future contracts to being put out of business.

Why is underinsurance still a problem?

In many cases, it’s because SMEs lack the time and expertise to assess their insurance needs. In other cases, they will underestimate the cover they need or they may undervalue their businesses to reduce insurance premiums.

Other SMEs fall foul of undervaluing what it would cost to rebuild a commercial property, which can differ from the market value.

According to the Royal Institute of Chartered Surveyors and Building Cost Information Service, a staggering 80% of businesses in England and Wales are underinsured on their properties.

The reason for this? They may have failed to factor in market fluctuations in property prices and possible delays in repairing the property.

Another problem is that SMEs might not be receiving the right guidance despite the rise of online brokerages that are designed to save time and keep costs low.

“This is becoming a big reason for underinsurance,” says James Tingley, head of SME commercial division at insurance brokerage Aston Lark. “The fact is, insurance policies still comprise a lot of technical jargon, despite efforts to simplify the process. SMEs can therefore become confused about what they’re insuring for, and how much cover is required.”

Insurance companies can play a major role in solving the problem by creating underwriting processes that are easier to understand and more straightforward. This can include eliminating complex jargon and creating onboarding processes that demand less information from business owners.

For example, SMEs are often required to provide significant amounts of information to insurers around revenue and profits, but this is not always quickly verifiable and leads to an insurance gap. Moreover, insurers can reduce friction and ease the burden by introducing more automation and streamlining the underwriting process.

Miscalculated profits can affect policies

A key policy for SMEs is business interruption (BI) insurance, which compensates for the loss of income after a disaster – and this is where many SMEs are tripping up.

In 2018, the Chartered Institute of Loss Adjusters found that nearly half (43%) of BI policies are underinsured by an average of 53%.The big problem is the indemnity period. This is how long SMEs think it will take their business to get back on its feet.

The British Insurance Brokers’ Association (BIBA) says it takes a small business about two years to fully recover. But it’s estimated around three quarters (75%) of BI policies have an indemnity period of just 12 months.

One of the major reasons for not having enough BI cover is when companies miscalculate their profits.

A gross profit basis is the most common choice of BI cover. But what an insurer defines as gross profit is vastly different to a business accountant’s definition – often resulting in a heap of confusion among small firms.

While most accountants will exclude staff wages and utility costs from gross profit, insurers do not – and will build in calculations such as payroll and ongoing employee costs. As such, firms should ensure their assessment of gross profit matches the one in the insurance policy.

Underinsurance is a headache for insurers

The risks related to underinsurance don’t just affect SMEs. Insurers also feel the hit as inadequate insurance premiums erupt into disputes and litigation between the policyholder and provider. With SMEs making up 99% of all businesses in the UK, the time and resources spent dealing with these disputes can be significant.

For insurers, the challenge is to not only educate SMEs on the dangers of inadequate cover – such as insolvency – but also to ensure they are being matched with the right blend of insurance products. Insurers want to model risk as accurately as possible and make sure the right claims are being paid out

The problem is that this has proved difficult in the past, in part because insurers and SMEs may have different definitions of what constitutes gross profit, or because companies experiencing rapid growth need to factor in rapidly rising revenues.

The solution to these challenges may lie in an underwriting process that makes better use of automation, injecting accurate insights into the process so that risk can be assessed more accurately. SMEs are often short on time and resources, which means a better customer experience is not just a nice-to-have, but essential to the success of their business. Time spent on admin and form-filling is time spent away from other crucial areas, and anxiety about insurance cover can eat into their bottom line.

Insurers can help to ease their burden by offering a streamlined service that takes advantage of live company data to determine the right level of cover for their needs.

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