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"If we don't tackle the underinsurance problem, customers will lose trust in insurance products."

September 11, 2023
Underinsurance indexing Katinka Slegt

The insurance industry is currently facing a great challenge to its fundamental purpose: the significant surge of underinsurance witnessed in recent years, which has left numerous policyholders worldwide inadequately insured. This trend not only undermines the very essence of what insurance aims to provide, which is to offer peace of mind, but also hampers the capacity of companies to expand, as sound insurance coverage is always essential for any commercial investment.

We discussed the topic with Katinka Slegt, former owner and Managing Director of Slegt Insurances (now part of Klap), a Dutch insurance broker company specialized in commercial property insurance. Katinka Slegt: "If we don't tackle the underinsurance problem, customers will lose trust in insurance products."

Insurance serves the need of people

Katinka: "I've been actively involved in the insurance industry since 1993, working both as an intermediary and an authorized agent . My experience spans across various sectors, including SME companies, family-owned businesses, and private clients. I've dealt with housing insurance as well as coverage for commercial properties, collaborating with different insurers along the way. My genuine passion within insurance lies in property damage coverage.

Insurance serves the needs of people. And offer businesses and people trust. Knowing you can rely on insurance during unforeseen events provides the reassurance to manage your business effectively while keeping long-term goals in sight.

Imagine yourself as an entrepreneur seeking growth – perhaps acquiring a building to facilitate expansion. By buying the building and by setting up a production line. When seeking financing for such endeavors, insurance often become a prerequisite set forth by lenders. The nice thing about it is you can help people grow their business.

This emphasis on accessibility is crucial, because insurance has to be an accessible product for society as a whole. Accommodating large corporations, medium-sized enterprises, small businesses, and people."

A threat to trust in insurance: underinsurance

Underinsurance arises when the insurance coverage obtained by policyholders falls short of adequately covering the costs associated with rebuilding, repairing, or replacing insured assets after a claim. This can result in substantial financial losses for claimants, as insurers often apply the 'Condition of Average'  to reduce claim settlements proportionate to the extent of underinsurance. To understand more where underinsurance comes from, read the article we've written about it before.

Katinka: "Underinsurance isn't a recent issue; rather, it's an inherent aspect of the insurance landscape.

As a policy holder, it's crucial to have confidence that your potential damages are adequately covered, ensuring proper compensation in case of a claim. This assurance is vital to safeguard both a company's ongoing operations and the well-being of a family. Therefore, underinsurance is a topic of all times.

Nevertheless, over the past 2-3 years, there has been a significant surge in underinsurance. This can be attributed to the escalating costs of reconstruction, driven by higher prices for building materials, increasingly stringent construction regulations, challenges in urban development, rising energy expenses, and the far-reaching impact of the Covid pandemic. These factors are affecting society at large. If we don't tackle the underinsurance problem, customers will lose trust in insurance products."

Indexing as a temporary solution

As underinsurance is a problem as old as insurance itself, it's only natural insurers have found a way to deal with it: by indexing sums insured, or the so-called index linking.

With indexation, insurers adjust sums insured  based on changes in the construction cost index. This to ensure that the insurance policy keeps pace with the rising costs of goods and services over time.

Katinka: "When it comes to increasing insurance coverage, carriers usually rely on indexation. And here's the catch – it always looks back in time. So, imagine you're paying your yearly premium, they're checking the index number against what it was a year ago. But that index number doesn't really keep up with how much underinsurance is happening nowadays. I think a lot of insured amounts are currently incorrect, considering all this."

Indexation is not a bad instrument. Prices change. When construction prices decrease, policy holders will come back to you saying "I'm paying for a rebuild value that's too high." So those fluctuations have to be dealt with. That's where the indexation comes from. The idea is good. But: if you don't start with the right basis, then it's garbage in, garbage out."

Let's have a look at this basis: reinstatement costs

The reason for this possible 'garbage in, garbage out' is incorrect reinstatement costs. Indexation is done over an original valuation of the reinstatement costs of a property. But if these reinstatement costs are incorrect, or outdated, it's very easy to end up with underinsured properties.

Reinstatement costs are determined through various methods depending on the property. Currently, options include conducting an on-site assessment, typically reserved for higher-value or industrial structures , performing desktop valuations, or having customers provide the necessary information. If these avenues are not feasible due to costs, particularly in cases of residential or smaller commercial buildings, estimating based on publicly available data becomes an alternative.

Katinka: "Depending on the activities within the building, the building's owner might offer their own rebuild valuation. However, this approach often lacks precision as it falls outside the owner's area of expertise. Alternatively, an outdated estimated insured amount might be adjusted with indexation, leading to an inaccurate rebuild valuation. Then the problem remains.

For larger commercial properties, evaluations are commonly conducted by specialized experts—real estate appraisers—who determine the reinstatement costs. They employ various methods, including desktop valuations, which involve assessing existing property data from multiple sources to ascertain building characteristics, materials used, and the construction year.

In many cases, experts also conduct on-site visits to inspect the property's interior, usage, and potential factors that might impact its rebuild value. Creating these reports is a resource-intensive process that comes with associated costs. If insurers use the reinstatement costs from the report as a basis for indexing, the validity of the report extends for 6 years, reducing the frequency of reinstatement cost evaluations to once every 6 years.

But: if a building's reinstatement costs were calculated five or six years ago, it's possible it's underinsured now. Because of the problems we've had in recent years, construction prices have increased much faster than indexing could guarantee. Many companies and insurers now advocate for a reassessment of the reinstatement costs properties in their portfolio, because there is a significant likelihood they might be underinsured by as much as 30%, 40%, or even 50%.

This is the task at hand. Many business customers are insured through intermediaries. These intermediaries bear a legal responsibility called the 'Duty of care' (referred to as 'Zorgplicht' in Dutch ) to ensure the adequacy of policies. This ‘Duty of care’ requires financial service providers to consider and act in accordance with the interests of their clients. Whether the customer actually takes action, is up to the customer."

Incorrect reinstatement costs due to property changes over time

A significant challenge carriers are struggling with is the evolving nature of buildings. They lack the necessary resources to effectively track these changes, leading to incorrect reinstatement costs and underinsurance. Additionally, when building regulations shift, new risks emerge within their portfolio, yet they are unable to pinpoint the properties associated with these risks.

Katinka: "There are instances where new or revised building regulations come into play. However, it's also important to note that people want to adjust their property every now and then. And they overlook informing their insurance providers about additions like solar panels or new structures they've introduced . Of course they forget to report that, because they are not daily thinking about adjusting their insurance.

Larger corporations tend to handle this better due to their employment of risk managers. But the semi-corporates, SME and residential home owners, it's just not in their DNA to be thinking, 'I've built a beautiful extension, let me report that to my insurance company'. This aspect of service, or 'Duty of care', falls within the industry's responsibility to effectively address collectively.

That doesn't mean that the responsibility of the end customer should be completely ignored. But I do think the insurance industry has a great responsibility to question their customers and help them be aware of the issue."

A new approach to calculating reinstatement costs is needed

Katinka: "Making rebuild valuations for every small property in a portfolio is difficult. There are simply not enough appraisers to assess thousands of properties every year. That's why our whole industry would be helped with a big data and AI solution . If you have big data solutions, you can serve the customer much better. And that's why Spotr is such a nice big data solution. To, on a very large scale and in a few seconds, see if this building is underinsured, yes or no."

Then the next step could be determining the right reinstatement cost. Additionally we see that many buildings are not only underinsured, but they also, for example, have added solar panels. Even though the customer should provide this updated information to the insurer, it would be amazing if you'd be able to distinguish all those changes with visual data. Making these changes visible on a large scale, so insurance policies can be adjusted accordingly.

In The Netherlands, for private lines, carriers often give a guarantee against underinsurance. Meaning, carriers are at serious risk to get too little premiums in to cover for possible claims, because the rebuild valuations, and with that the insured sums, are too low. Meaning the carrier will then pay out more in claims than he gets in with premiums."

Flooding in the UK. Photo by Chris Gallagher.

The world is changing, so must insurance

Property insurance claims are rising all over the planet, due to more extreme weather , causing damages to homes, businesses and society as a whole.

Katinka: "I think the world is changing. The world and society. Underinsurance in specific is a societal problem that we have to solve together. Insurance carriers are a very important part of society and they are judged by every national regulatory body.

I see that big carriers are now taking the lead to ensure that policies are in order. They start working more and more with big data. Because: the more data, the better the insurance protection.

Due to climate change, we are experiencing an increasing amount of storm damage. In the past, fire and flood damage were major issues within the insurance industry. Lately, there have been numerous instances of storm damage and floods. And: entire regions are being affected, rather than just individual properties.

As a result, insurance companies are progressively concentrating on how we can assist our customers in preventing damage. I think it's good that we as an insurance industry make sure that our customers are aware. This entails informing our customers about what actions can be taken, what they can do independently, and how we can provide assistance. We play such an important role in society. Let's make sure that properties will remain insurable in the future."

Modern challenges require innovative solutions

Katinka: "There are many challenges in the insurance industry, but we are smart and inventive enough to take on that job.

Innovation is of huge importance. While a substantial portion of insurance has already been automated, any processes that can be automated and resolved through extensive data and AI solutions are vital for the modernization of the insurance sector. I see AI playing a pivotal role in this transformation.

I also think the insurance industry is going to change a lot. For example, as opposed to our current emphasis on individual ownership and insurance, I believe there will be a shift towards shared ownership. Why do we all need to own a car if you can share one?

This shift can be made much more insurable by leveraging the potential of big data and AI. AI and digital transformation, those are the keyword for the coming years."

Underinsurance Katinka Slegt

About Katinka Slegt

Katinka Slegt (53) has been working in insurance since 1993. She ran her broker company Slegt Insurances for 20 years, focusing on property insurance for SME and larger residential properties. Katinka sold the business in 2020 and is now active in the Spotr Advisory Board, she advises startups and other SME companies and acts as chairman of Fidonna, a platform to help woman achieve financial independence.