Underinsurance – A Hidden Risk for many companies

By Jens Erik Nielsen, Head of Aon Global Risk Consulting in Aon Denmark, and Mikkel Mortensen, Head of Account Management in Aon Denmark

Underinsurance is a material and growing risk for many companies in the Nordics as well as in other regions, with the potential to create avoidable financial losses, earnings volatility and balance‑sheet strain when major claims occur. It is therefore a management issue and not just an insurance detail.

What is the issue if a company is underinsured?

Underinsurance occurs when the sums insured on a policy are lower than the true replacement or restoration cost of the insured assets and interests. This has very concrete consequences:

• In many property policies, insurers are contractually entitled to reduce the claim payment proportionally if values are too low (average/proportional clause). If a site is insured for only 70% of its true value, the insurer may pay only 70% of any partial loss.

• After a major loss, the insurance cover may therefore not be sufficient to fully rebuild or replace damaged assets. The gap must be financed from the company’s own balance sheet, which can quickly become a liquidity and P/L issue.
  
  

In today’s environment of persistent inflation, higher construction and equipment costs, and supply chain disruption, we see an increasing number of cases where companies only discover that they are underinsured when a claim occurs – and the insurer has a clear contractual right to reduce the payout.

Underinsurance is a material and growing risk for many companies in the Nordics as well as in other regions, with the potential to create avoidable financial losses, earnings volatility and balance sheet strain when major claims occur. It is therefore a management issue and not just an insurance detail.

Why underinsurance is a growing issue

Underinsurance is an underestimated risk in corporate insurance programs, and it is particularly relevant in today’s environment of inflation, supply chain disruption, and rapidly changing asset values.

For many companies, the insured values on their policies do not reflect the current replacement cost of their assets. Renewal values are often based on historic purchase prices, accounting values or outdated replacement estimates rather than up‑to‑date rebuilding and equipment costs. The result can be significant, and avoidable, financial losses when a major claim occurs.

Several trends make underinsurance critical in the Nordics:

• Labor, materials, and energy costs have increased substantially across Europe. If sums insured are based on outdated valuations, they will likely fall short of actual replacement or restoration costs after a loss, across all relevant insured assets and interests.

• Persistent inflation and volatile commodity prices mean that values can move quickly year‑on‑year. Even a program that was adequate two or three years ago may now be materially underinsured.

• Nordic and European companies often rely on specialized machinery and global suppliers. Replacing key equipment or re‑establishing a production line can be far more expensive and time‑consuming than originally estimated.
  
  

Combined, these factors mean that often the declared property values (machinery, inventory) deviate markedly from real‑world replacement costs.

“We increasingly see that, when we challenge the status quo on reported values, the sums insured do not match the real replacement costs. Too often companies only discover they are underinsured once a loss has occurred and the gap between the insured amount and the actual asset values very quickly becomes a cash issue on the bottom line,” says Mikkel Mortensen, Head of Account Management in Aon Denmark.

A governance and strategic risk – not just a technical detail

Underinsurance is therefore not only a technical insurance issue; it is a governance and strategic risk that resides on the agenda of top management. Some elements of this risk are:

• Underinsurance threatens business continuity and strategic plans. A major loss that cannot be fully financed by insurance may delay or derail growth initiatives, M&A integration, capacity expansions or sustainability investments. It can also damage relationships with key customers if the company cannot resume operations quickly.

• Underinsurance translates directly into financial risk. Claim shortfalls hit the P/L, strain cash flow, may trigger covenant pressure, and increase the cost of capital. Risk transfer should be aligned with the company’s balance sheet strength and financial targets, so that reported earnings are not exposed to avoidable volatility.

• With an increased focus on resilience, risk governance, and downside protection, underinsurance can signal weaknesses in internal controls and risk management. In a severe event, shareholders and other stakeholders may question whether internal oversight responsibilities were fulfilled if material, avoidable losses arise due to inadequate insurance values.
  
  

In this sense, accurate insured values are part of a company’s overall resilience strategy and an important component of sound corporate governance.

How underinsurance creates unnecessary losses

When a loss occurs – fire, explosion, storm damage, machinery breakdown – underinsurance can materially reduce the insurance payout in several ways, for example:

• Proportional clause
  If a policy includes an average clause and the property is underinsured; the claim payout is reduced in proportion to the underinsurance. For example, if a site is insured for only 70% of its true value, the insurer may pay only 70% of any partial loss.

• Insufficient funds to rebuild or replace
  Underestimated machinery and inventory values mean that after a major loss, the available insurance proceeds do not cover full reconstruction. The company must fund the gap from its own balance sheet, potentially delaying the return to full operations.

• Strategic and reputational impact
  Extended downtime, inability to meet customer demand, and pressure on liquidity can damage customer relationships, market position and brand – effects that may outlast the immediate loss event.
  
  

In many cases, these losses are avoidable with more accurate and frequently updated insured values.

Reduce the risk of underinsurance by simple actions

Properly aligned insured values help protect earnings quality, stabilize cash flows and support a stronger risk narrative towards stakeholders. To minimize the risk of underinsurance, the following activities can help mitigate the exposure:

• Use independent and experienced valuation professionals for obtaining updated and documented values

• Use standardized methodologies and documentation which can easily be updated

• Focus on key sites and high impact assets to reduce the exposure where it matters the most

• Integrate with insurance design and optimize sums insured, limits, sub‑limits, deductibles and coverage structure

• Perform periodic updates and benchmarking to ensure that values are not reflected as historic purchase prices or accounting values
  
  

“When we help clients get their values right, it’s not just about numbers in a policy – it’s about creating a better basis for decision‑making and more resilient businesses in the long term,” says Jens Erik Nielsen, Head of Aon Global Risk Consulting in Aon Denmark.

By aligning insurance values with true replacement costs and following some simple housekeeping rules, companies can thus:

• Reduce the risk of average clause reductions and claim shortfalls

• Improve the reliability of their risk‑financing strategy

• Enhance financial resilience and protect key financial metrics

• Demonstrate strong risk governance to boards, lenders and investors