A Hot Topic – The Risk of Underinsurance
The issue of underinsurance and the effect this can have on claims is a hot topic, and it has
received ample attention in the national media. The Central Bank’s recent thematic review of
domestic policies identified several risks, and the actions now required of Insurers, in order that they can clearly and effectively communicate with their household policyholders around underinsurance and its effects. These risks are indeed real and they often have devastating consequences for consumers; generally householders who are typically unsophisticated buyers of insurance.
The Role of the Insurance Broker
Brokers will know that the consumer carries the full burden of unilaterally accurately
selecting a value at risk but also carries the full risk of underinsurance in the event of an insured loss. Brokers as agents for the policyholder can provide a valuable advisory role but are constrained by the very many market variables and limitations, not least of which is price competitiveness and available product.
As policyholder claim representatives we, far too frequently, see the punitive and damaging
effects of the underinsurance clause. We make plain that no-one benefits from insuring their
property for less than its full reinstatement value. For domestic policyholders, who are
insuring what is likely to be their most valuable (or only) asset, getting the sum insured right
should be fundamental to the contract. A similar situation pertains in relation to household contents sums insured with even less reference market pricing data being made available.
However, and specifically in the context of domestic insurance policies, we do not believe
that the incorporation of average clauses is appropriate and that there has been little or no
debate around this contention. These policyholders are not sophisticated buyers of
insurance, and the Central Bank’s review effectively acknowledges this fact. Why then
penalise consumers with a clause that was designed for commercial insurances?
The Effect on the Consumer
Brokers will be aware that most property insurance claims are not total or near-total losses. Instead, the majority of valid claims are characterised as being of small or medium value in terms of ultimate payments. However, the application of the ‘underinsurance clause’ to even small or medium sized losses often has a disastrous effect for our and the insurance companies’ clients – who are then compelled to fund the difference with recourse to savings or borrowings. If they are not in the market for loans then they are faced with the prospect of being unable to carry out repairs in full.
In times of run-away construction inflation and general inflation (leading to a ‘cost of living crisis’) it is extremely difficult for buyers of domestic insurance policies to:
(1) accurately project forward the reinstatement cost of their home over a 12-month period and,
(2) fund any shortfall caused by the application of the ‘underinsurance clause’ when a claim does arise.
Savings are now being used to backfill day-to-day expenditure and the cost of borrowing is increasing steadily to combat inflationary pressures.
Background
It appears that the first record of the ‘average’ principle in relation to insurance was from a minute of the Fire Committee of the Royal Exchange Assurance Corporation in January 1722 where it was ordered:
“If in case of loss…it appears that there was a greater value than the sum insured hereby and part thereof is saved, then this loss..shall be taken and born(sic) in an average.”
We all know that payment subject to average means payment limited to the proportion of the actual loss which the sum insured bears to the actual value of the property insured at the time of loss. In such circumstances the Insured is deemed to his own ‘insurer for the residue’
– British & Foreign Ins Co Limited v Wilson Shipping Co Limited [1921] 1 AC 188
Average, of course, is not required by law except in the case of Marine Insurance, see S.81 of the Marine Insurance Act 1906.
Consumer Insurance Contracts Act 2019
One of the problems is that homeowners, as a cohort, are not necessarily sophisticated buyers of Insurance. The Consumer Insurance Contract Act (CICA) was an attempt by the legislature to counterbalance the expertise and resources of the Insurers. However, in the context of underinsurance, CICA offers no succor to policyholders and Insurers remain unfettered in their reduction of their liabilities in respect of property claims that are not total-losses.
The UK Position
One wonders whether this is exclusively an Irish phenomenon? Or instead, is it perhaps
evidence of the dearth of goodwill within the Irish Insurers’ claims departments?
John Birds in his ‘Modern Insurance Law’ [Sweet & Maxwell], notes that:
“Commercial policies generally contain average clauses and it has been suggested that the
principle of average would be implied, if not expressed, in commercial policies on goods*.
However, average policies are unusual, it seems, in household policies, except those issued
by Lloyds Underwriters, and there is clear authority that the principle of average will not be
implied to such a case. ** ”
Birds’ analysis of ‘average’ in the UK household insurance market appears to be borne out by even a cursory glance at the covers available. A trawl through the household policy booklets of UK insurers (that also have an Irish imprint) shows that ‘average’ will not be applied where the cost of rebuilding the property is less than the sum insured. It could be said that the policy ‘reverts to indemnity’ although this is probably a poor choice of words. It reflects the fact that the (UK) Insurer will not settle the claim on a ‘new for old’ basis and will instead apply deductions to reflect wear and tear.
Average in Practice
One must wonder then, why have Irish Insurers adopted a clause that really only belongs in commercial insurance contracts? As will be appreciated, trying to determine an accurate rebuilding cost for any domestic premises is somewhat a fool’s errand at this point – akin to trying to hit a moving target.
The application of the average clause also raises very serious issues in and of itself, namely: The calculation of the rebuilding cost of any premises is never an exact science. There will be a range of values appropriate. In truth, the rebuilding cost of an insured property can only ever be conclusively determined in the event of a total loss, i.e. the actual rebuilding cost, not the ‘notional’ rebuilding cost.
The SCSI Position
The Society of Chartered Surveyors Ireland do attempt to provide some guidance to homeowners around this subject. However, they make plain that their advice can never be conclusive as it deals only with estate type houses built since the 1960s’ and even then only within the geographical areas of the main metropolitan population centres in the State. The published rates of the SCSI are guideline only and are qualified accordingly. Caution should be exercised, particularly in the case of one-off bespoke dwellings, existing dwellings that have substantial energy retrofits and upgrades as well as new properties with significant A energy ratings.
Insurers (and their adjusters) treat the SCSI rebuilding rates as ‘gospel’ allowing little
deviation or negotiation. You will note that the SCSI guide does not form any part of the
insurance contract/policy and that there are no insurers that I am aware-of who provide a
formula or analysis as to how ‘underinsurance’ is to be determined.
The experience at the claims end has and continues to be conflicting in the Irish market. In
the event of a domestic buildings claim, the market rates applied by insurers to the buildings
value at risk calculation will typically be based on published rates, e.g. SCSI House
Rebuilding Guide, but many insurers continue to instruct their adjusters or claim handlers,
inhouse and otherwise, to value the actual buildings losses sustained based on outdated,
unrealistic rates, valuations and schedules, which have not been reviewed or updated for
many years and which are not commensurate with the real world value at risk, or indeed the
premium paid for same.
Conclusion
We think the UK approach is instructive. We can see that, legally, the UK Courts will not import/imply an average clause into a household insurance policy. There must be a reason for this reticence to do so – i.e. that a domestic policyholder cannot be an expert in determining the building sum insured. Accordingly, the UK Insurers, typically, have not sought to punish their policyholders in the same way that most Irish Insurers now do.
In these times of Consumer Protection Codes, Consumer Insurance Contracts Acts and the
like, the prevalence of the average clause in Irish household insurance policies appears to
be an anomaly. The issue may have been less contentious during times of a settled
construction market and modest construction inflation that mirrored the general rate of
inflation. However, the issue has now become the key factor that limits claim payments,
often with catastrophic effects for the policyholder. It means that non-average policies must
now represent premium, sought-after, products.
Client Advocates
It goes without saying that every domestic policyholder has a manifest interest in insuring his
or her property for full value. We work with our clients and their brokers to encourage
precisely this behaviour. No-one will truly ever know how much it will cost to rebuild their
home until it has been completely destroyed. Thankfully, this is a rare event, making the
calculation (for most policyholders) a purely hypothetical one.
However, this notional estimation is being used by Insurers to reduce the level of payments
for ordinary or run-of-the-mill domestic claims undermining the value of insurance generally
and causing real hardship for consumers.
OMC Claims are always readily available to offer advice and guidance around the topic of underinsurance to Brokers and their clients. In the meantime, surely underinsurance clauses should be stricken from domestic policies in favour of a less punitive mechanism that reflects – upon the claim –
the fact that the property is underinsured?
John O’Donoghue, Managing Director, OMC Claims
*Carreras Limited v Cunard Steamship Co [1918] 1 K.B. 118
**Sillen v Thornton (1854) 3 E&B 868
This article originally featured in Irish Broker Magazine, December 2022
