Why Your Businesses May Be Underinsured Right Now *

A manufacturing business in regional Victoria made a claim after a fire gutted part of its warehouse. The policy was legitimate. The broker had placed it properly. The insurer paid — but not in full. The payout covered less than two-thirds of the loss.

Nobody had done anything wrong, exactly. The sum insured had simply never kept pace with what the building and its contents actually cost to replace. The policy was valid. The coverage was not.

This is underinsurance. And it is far more common than most business owners realise — not because they are reckless, but because no one has ever sat down and explained how it works.

What is underinsurance?

Underinsurance occurs when the amount you have insured an asset for — your sum insured — is less than what it would actually cost to rebuild, repair or replace it in the event of a total or partial loss.

The gap can be modest or it can be catastrophic. Either way, the consequences become visible at the worst possible moment: when you are in the middle of a claim.

Research from the Insurance Council of Australia has consistently found that a significant proportion of Australian commercial properties are underinsured — some estimates suggest the majority. The problem is particularly acute in commercial property, industrial assets, and businesses with high-value plant and equipment.

The average clause: the policy condition that will surprise you

Most commercial insurance policies in Australia contain what is known as an average clause (sometimes called a co-insurance clause). If you are not familiar with it, you should be — because it is the mechanism that determines how much you actually receive when a claim is paid.

Here is how it works in plain terms:

If your sum insured represents only a portion of the true replacement value, your insurer will reduce your claim payout by that same proportion.

A worked example makes this concrete:

In Scenario B, the business owner insured their property for $1.2 million. Perhaps that was the original build cost. Perhaps it was a figure someone picked at renewal without checking. Either way, the actual replacement value had grown to $2 million — meaning the property was only 60% insured.

When the storm claim came in, the insurer applied the average clause and paid 60 cents in the dollar. A $400,000 claim became a $240,000 payout. The business absorbed a $160,000 shortfall — not because anything was disputed, but because the sum insured was wrong.

Why underinsurance happens

Underinsurance is rarely deliberate. It is almost always the result of inattention compounded by time. The most common causes:

• Sums insured set years ago and never reviewed. A figure that was accurate in 2019 can be materially wrong today — not because anything changed on paper, but because costs have.
• Using market value instead of replacement cost. These are not the same thing. Market value reflects what a buyer would pay for your property. Replacement cost reflects what it would cost to rebuild it from scratch — often substantially more.
• Improvements not disclosed. Fit-outs, renovations, equipment upgrades. If the asset has changed but the policy has not, the gap widens.
• Assuming the broker or insurer updates it automatically. They do not. Without instructions or a formal valuation, the sum insured stays where you last set it.
• Rounding down at renewal to reduce premium. This is a false economy. A lower premium saves hundreds. A coverage shortfall at claim time can cost hundreds of thousands.

The inflation factor

Post-pandemic construction costs in Australia have risen sharply and, in many sectors, have not fully retreated. The Australian Bureau of Statistics has documented significant increases in residential and commercial construction indices since 2020. Materials costs, labour shortages, and supply chain disruption have all contributed.

A sum insured that accurately reflected your replacement cost in 2021 may now be 30–50% too low — without a single change to your physical property.

This is not a hypothetical risk. Brokers across Australia are seeing it play out in real claims, particularly in commercial property and industrial sectors where construction costs are most sensitive to materials and trades pricing.

If your sum insured has not been formally reviewed since before 2022, it almost certainly needs revisiting.

Why this is happening now (more than ever)

1. Costs have risen fast
Construction, materials, labour, equipment have all gone up.
What cost $500,000 to rebuild a few years ago might now cost $650,000+.

2. Businesses have changed; but policies haven’t
Many businesses have evolved; but their insurance hasn’t kept up.

3. Pressure to reduce costs
Some businesses are cutting cover to save money.
It feels like a smart move… until something goes wrong.

4. Business interruption is often misunderstood
Recovery takes longer than most people think; especially now.

What to do about it

The good news is that underinsurance is fixable — and the fix does not have to be complicated.

• Commission an independent replacement cost valuation. Not a market appraisal. Not a desktop estimate. A proper valuation by a quantity surveyor or specialist valuer that calculates what it would actually cost to rebuild your asset today.
• Review your sums insured annually — not just at renewal. Renewal is the prompt, but the conversation should happen before your broker submits to market.
• Tell your broker about any changes. Fit-outs, equipment purchases, building extensions. If the asset changes, the sum insured should change with it.
• Ask your broker to walk you through the average clause. If you have never had this conversation, ask for it at your next renewal. You should understand exactly what happens to your claim payout if your sum insured is short.
• Consider an agreed value policy where appropriate. For certain assets, an agreed value policy removes the average clause entirely — the insurer pays the agreed amount in the event of a total loss, without applying proportional reduction.

How SMART approaches this

A sum insured review is part of every renewal conversation at SMART — not an afterthought, and not something we leave to the client to initiate. For commercial property clients in particular, we look at when the last independent valuation was done, what has changed on the property, and whether the current sum insured reflects current construction costs.

We would rather have an uncomfortable conversation about a coverage gap now than a very difficult one in the middle of a claim.

If you own or manage commercial property, industrial assets, or any business with significant physical assets and have not had a formal replacement cost review in the last two to three years, it is worth doing before your next renewal — not after.

A SMART example:

The commercial property owner thought $6,000,000 was enough.

It wasn’t even close.

A commercial property owner came to us insured for just over $5,000,000. Based on the size of the building, our insurance broker flagged that this looked low and recommended a review of the sums insured.

The owner agreed to increase the cover to $6,000,000 at renewal. It felt like a reasonable step up.

But our Smart Business Insurance broker pushed further.

The only way to know with certainty whether a sum insured is adequate is to obtain a professional property valuation. Not an estimate. Not a gut feel. A valuation.

The client agreed.

The replacement cost came back at over $8,000,000.

That’s a $3,000,000 gap on the original cover, and still $2,000,000 short of where the owner thought they’d landed.

Here’s where it gets better.

Our Smart Business Insurance broker negotiated a lower rate with the insurer so that the policy didn’t increase proportionally with the higher sum insured. The cover was updated to reflect the full $8,000,000 replacement value , without a premium increase that matched the jump in cover.

The property owner avoided a potentially devastating underinsurance position at claim time. And they paid less than they might have expected to get there.

“Here’s the part most people miss: Claims don’t just get accepted or denied , they can get reduced. Being underinsured and not knowing it until it’s too late is a massive risk for business owners”
Mark Vanzo, Managing Director, SMART Business Insurance.

Ready to review your sums insured?

Talk to the SMART team before your next renewal. We work with commercial property owners, investors and operators across Australia to identify coverage gaps before they become claim shortfalls.

Get in touch → smartbusinessinsurance.com.au