If you’ve ever made a claim on your business insurance only to discover your payout doesn’t cover your actual losses, you’re not alone. Underinsurance is a silent trap that catches many business owners off guard – especially during times of crisis.
In this win, we helped a café owner recoup losses from their insurance broker after demonstrating that the broker failed in their duty of care when advising on and arranging our client’s business interruption insurance, including annual renewals.
What is underinsurance, and how does it work?
Underinsurance occurs when the amount of cover on your insurance policy is less than the actual value of the assets or income you need to protect. This can have serious consequences when you make a claim and leave you significantly out of pocket – even if the insurer otherwise accepts your claim.
Many policies require that a business insured for business interruption under their policy takes out cover that is at least 80% of the business’ income or gross profit (whichever is insured under the policy).
Those policies also contain what is commonly called an “average clause” or “co-insurance clause”. This means that if you take out business interruption insurance at less than 80 percent of your income or gross profit (usually measured over 12 months), the insurer’s liability is reduced. The reduction is made in proportion to how far below the required 80 percent your sum insured is.
Here's an example
- Your business earns $500,000 in income over a 12-month period;
- You would typically need to take out cover of at least $400,000 (80% of earnings) to avoid the underinsurance adjustment on a claim;
- If you only insured your business for $300,000 in loss of income, you are insured for only 75% of the minimum required amount under the policy;
- The insurer would only be required to pay you 75% of any benefit in your claim. That is, you would lose 25% of your claim to underinsurance.
Underinsurance clauses most commonly appear in business insurance and commercial property insurance policies. Although they can appear in other types of policies (for example, home and contents insurance or landlord insurance), this is not common.
Insurance brokers’ duty to ensure adequate cover
Underinsurance often happens because of incorrect valuations, outdated sums insured, or poor advice from insurance brokers.
Insurance brokers in Australia owe their clients a duty of care to render their services with due care and skill, ensure the services and products recommended are reasonably fit for purpose, and must act efficiently, honestly and fairly.
This includes taking reasonable steps to understand your business, assess its risks, and recommend appropriate cover. Brokers must ensure that the sum insured and policy terms are sufficient to protect against reasonably foreseeable losses. They are also expected to explain the implications of underinsurance and provide clear advice on how cover levels were calculated. Failure to meet these obligations may result in grounds to seek compensation if you suffer a loss because your cover is not adequate for your business’ needs.
Professional indemnity insurance: a safety net for broker errors
Insurance brokers in Australia are required to hold professional indemnity (PI) insurance. This policy is designed to cover claims made against them for negligence, errors, or omissions in their professional advice.
In cases like this, where a broker fails to arrange adequate cover, their PI insurance often funds the compensation paid to the client. This means that even if your broker made a costly mistake, there is usually a financial safety net available to help you to recover your losses.
The café owner’s story
When COVID-19 lockdowns hit Victoria, a Melbourne café owner relied on their business interruption insurance to survive. After initially resisting the claim, the insurer eventually agreed to pay, but the payout was far less than expected.
Why? The café owner had not taken out enough cover and was underinsured. It had taken out cover of only around half of what it needed and so the insurer only had to pay around half of the insurance benefit, costing the family business thousands of dollars.
Insurance broker failed in its duty of care
The café’s policy had been arranged by an insurance broker. The owner had trusted their insurance broker to arrange adequate cover. However, the broker had failed to properly consider the café’s risk exposure and the level of cover it needed to be adequately insured if something went wrong.
The broker also failed to reconsider the sum insured on renewal of the policy each year and simply sent a bill at renewal time to roll over the cover without any real consideration of the business’ performance.
The broker also never explained what underinsurance was to the café owner and how to avoid it, meaning our client had no idea that any claim he made would only be partially paid.
Cafe owner lodges a complaint with the Australian Financial Complaints Authority (AFCA)
Instead of walking away, the café owner lodged a complaint with the Australian Financial Complaints Authority (AFCA). AFCA is an independent body that helps resolve disputes between consumers and financial service providers, including insurance brokers.
The complaint argued that the broker failed in their duty of care by:
- not properly assessing the café’s revenue and risk at the relevant time;
- recommending insufficient cover;
- failing to warn about the consequences of underinsurance.
Cafe owner compensated
Through AFCA’s conciliatory process, the broker agreed to a financial settlement to compensate the café owner for the shortfall on the insurance claim. While the insurer’s payout didn’t change, the settlement negotiated by Berrill & Watson with the broker helped the café recover the lost benefits and keep its doors open.
Options if your business is underinsured
If you’ve suffered a financial loss because your business insurance cover was too low, you may have options:
- Seek legal advice early, as you may be entitled to compensation;
- Review your policy and the advice given to you (or not given to you) by your insurance broker;
- Consider lodging a complaint with AFCA or taking court action.
Get help from an insurance lawyer
Underinsurance doesn’t have to mean the end of the road. If your broker failed to protect your business properly, you have rights, and we can help you enforce them.
Make sure you:
- Review your cover regularly. Business circumstances change – make sure your insurance keeps up.
- Ask for written advice from your broker about how your sum insured was calculated when taking out or renewing your cover.
- Know your rights. If you make an insurance claim and your insurer says you are underinsured, get advice on your options to recover the money from your insurer or your broker.
Contacting Berrill & Watson
📞 Melbourne: 03 9448 8048
📞 Brisbane: 07 3013 4300
📞 Anywhere else in Australia: 03 9448 8048
How we charge
We are Australia's best-value superannuation/insurance law firm. Other law firms charge nearly double (& sometimes more than double) what we charge. So, if you get a quote from them, or have a cost agreement, ask us what we will charge you.