Commercial Property Underinsured? Challenge the Rebuild Cost

A commercial property insurer may accept that the damage is covered but still reduce the payment substantially because it believes the building was insured for less than its full reinstatement value.

In a large property claim, that reduction can run into tens or hundreds of thousands of pounds. The insurer may refer to underinsurance, inadequate sums insured or an “average” clause.

But identifying underinsurance is only the beginning of the analysis. You need to understand how the insurer calculated the correct rebuild cost, what the policy actually says and whether the resulting reduction has been applied properly.

If the insurer says your commercial property should have been insured for substantially more than the figure on the policy, ask to see the evidence behind that conclusion before accepting the reduction.

Why has the insurer reduced the claim?

Commercial property policies commonly require buildings to be insured by reference to their reinstatement or rebuild cost rather than their market value.

If the sum insured is lower than the value required by the policy, the insurer may seek to reduce a claim where the wording permits it.

The insurer's position may depend on several separate questions:

What rebuild cost has the insurer used?

Ask for the figure, valuation date, methodology and supporting report behind the insurer's reinstatement-cost assessment.

What did the policy require?

Check the definition of buildings, sum insured, declared value, reinstatement value and any basis-of-settlement wording.

Is there an average clause?

Locate the precise term allowing a proportionate reduction and check when the policy says it can be applied.

What was declared at inception or renewal?

Review proposal forms, statements of fact, renewal documents, valuations and broker correspondence.

Is the insurer comparing like with like?

Make sure its valuation uses the same property, specification, insured items and reinstatement basis required by the policy.

Market value is not the same as rebuild cost

One of the most important distinctions in a commercial property claim is the difference between the value of a property on the open market and the cost of rebuilding it.

A building may sell for £1 million but cost considerably more — or less — to demolish, clear and reinstate after a major insured loss.

Reinstatement costs can be influenced by matters such as:

demolition and debris removal;
labour and material costs;
professional fees;
architect, surveyor and engineering costs;
building regulations and statutory requirements;
site access and logistical restrictions;
specialist construction methods or materials;
listed or unusual building features;
local construction-market conditions;
inflation during the rebuild period; and
VAT where relevant to the insured and policy basis.

That is why using the purchase price or market valuation as a substitute for a reinstatement-cost assessment can create serious problems.

Has the insurer's rebuild-cost figure been overstated?

If the insurer's figure is substantially higher than the amount for which the property was insured, examine the valuation itself.

Useful questions include:

Who prepared the valuation?
What qualifications and methodology were used?
Was the property actually inspected?
What floor area and specification were assumed?
Which construction rates were used?
What allowance was made for professional fees?
Were demolition and debris-removal costs included?
What inflation allowance was applied?
Was VAT included, and was that appropriate?
Were improvements made after the original sum insured was set?

A rebuild-cost figure should not be accepted merely because it appears in a loss adjuster's report. The methodology and assumptions can be tested.

A £500,000 difference in valuation can have a much larger effect than expected

The dispute is not confined to the cost of rebuilding the entire property. Where an average clause applies, a finding of underinsurance can potentially reduce even a partial-loss claim.

That makes the underlying valuation particularly important where the commercial loss is substantial.

How does an average clause work?

The precise calculation depends on the policy wording. A common approach is to reduce the claim in proportion to the degree of underinsurance.

Illustrative example only

Building insured for £1.5m — insurer says rebuild cost is £2m

On a simple proportional basis, the property would be insured for 75% of the alleged reinstatement value.

If a covered loss were £400,000, an average calculation using that percentage could reduce the payment to £300,000 — a £100,000 difference.

The actual outcome depends entirely on the wording and facts of the individual policy.

This is why a dispute about the insurer's rebuild-cost figure can matter even where the physical damage itself costs far less than the total sum insured.

Does the policy actually allow the reduction?

Do not assume that every reference to underinsurance automatically entitles the insurer to apply the same formula.

Commercial policies vary. Some contain traditional average clauses. Others use different declared-value, day-one or reinstatement provisions, thresholds or bases of settlement.

Check:

the buildings definition;
the schedule and sum insured;
the basis-of-settlement clause;
any average or underinsurance clause;
declared-value provisions;
day-one uplift provisions;
index-linking clauses;
endorsements or special conditions; and
any underinsurance tolerance contained in the wording.

The insurer should be able to identify the precise policy wording on which the reduction depends.

What if the policy was written on a Day One basis?

Many commercial property policies use a Day One reinstatement basis. The business declares a reinstatement value at the start of the period, while an uplift provides some protection against inflation during the policy and rebuilding period.

That uplift should not automatically be treated as a substitute for setting an accurate declared value in the first place.

If the insurer alleges underinsurance, check which figure it is comparing with the declared value and how the wording says that comparison should be made.

Was the original sum insured based on professional advice?

Evidence showing how the insured figure was originally selected may become important once an underinsurance dispute arises.

Look for:

a reinstatement-cost assessment;
a surveyor or quantity-surveyor valuation;
a lender's valuation containing a rebuild figure;
broker recommendations;
renewal questionnaires;
statement-of-fact documents;
emails discussing sums insured; and
any index-linking information supplied by the insurer.

This can help establish whether the disputed figure arose from the policyholder, a professional valuation, the broker, the insurer's process or a combination of factors.

Could the broker's role matter?

Potentially.

Many commercial policies are arranged through brokers. Whether a broker has any responsibility for an inadequate sum insured will depend on the service it agreed to provide, the information supplied by the business and the advice actually given.

A broker is not automatically responsible whenever underinsurance exists. Equally, the existence of a broker does not mean the circumstances in which the sum insured was selected should be ignored.

Preserve proposal forms, renewal correspondence, recommendations, demands-and-needs documents and any discussion about valuation.

What if the insurer says there was a failure to make a fair presentation?

Commercial insurance can also raise separate issues under the Insurance Act 2015.

If the insurer argues that the business failed to make a fair presentation of the risk before the policy was entered into or renewed, that should not simply be merged with the average-clause calculation.

The insurer may need to establish what information should have been provided and what it would have done differently had the risk been fairly presented.

Depending on the circumstances, the available remedy may therefore involve a different analysis from simply applying a contractual underinsurance percentage.

“The building was underinsured” may describe the problem, but it does not by itself answer which contractual or legal remedy the insurer is entitled to use.

Free business insurance guide

The Business Insurance Claim Dispute Guide

Dealing with a rejected, delayed or underpaid commercial insurance claim? Our guide explains the issues businesses should consider before accepting an insurer's position.

It covers underinsurance, business interruption, warranties, non-disclosure, commercial property claims, loss adjuster disputes and evidence.

Read the Business Insurance Claim Dispute Guide

What evidence can challenge the insurer's rebuild cost?

Depending on the property and dispute, useful material may include:

the policy schedule and complete wording;
the insurer or loss adjuster's rebuild-cost assessment;
the original reinstatement-cost assessment;
a current or retrospective assessment from an appropriately qualified professional;
quantity-surveyor evidence;
building plans and measured floor areas;
construction specifications;
recent building or refurbishment costs;
contractor estimates;
professional-fee estimates;
evidence of demolition and debris-removal costs;
building-regulation requirements;
information about access or site constraints;
proposal and renewal documents; and
broker correspondence.

The objective is not simply to obtain a second figure. A strong alternative valuation should explain its methodology and why it better reflects the reinstatement basis required by the policy.

Before accepting an underinsurance reduction

If the reduction is substantial, ask the insurer to set out its position clearly in writing.

Request:

the full rebuild-cost figure it relies upon;
the valuation report or supporting calculation;
the valuation date;
the exact policy clause relied upon;
the percentage of alleged underinsurance;
the complete average calculation;
any separate fair-presentation allegation; and
the insurer's explanation of the remedy it says applies.

That turns a broad statement that the property was “underinsured” into a series of propositions that can actually be tested.

How Insurance Dispute Service may help

Insurance Dispute Service reviews commercial property claims where insurers have reduced settlements because of alleged underinsurance.

We can examine the policy wording, sums insured, insurer's valuation, average calculation, renewal evidence and relevant professional reports to identify where the reduction appears open to challenge.

Depending on the circumstances, that may involve questions about the rebuild-cost assessment, the operation of the average clause, the information supplied at renewal, the broker's role or the remedy the insurer is seeking to apply.

Read more about our Underinsurance Disputes service or Commercial Property Insurance Claim Disputes .

Your free complaint options

You do not need to use a claims management company to complain to your insurer. You can complain yourself for free. If eligible, you can also refer an unresolved complaint to the Financial Ombudsman Service yourself for free.

Frequently asked questions

Can an insurer reduce a partial commercial property claim for underinsurance?

Potentially. Where the policy contains an applicable average or underinsurance provision, a proportionate reduction may apply even though the cost of the individual loss is below the total sum insured. The exact result depends on the wording.

Is commercial property market value the same as rebuild cost?

No. Market value concerns the value of the property as an asset. Reinstatement cost concerns the cost of rebuilding or reinstating the insured property on the basis required by the policy.

Can I obtain my own rebuild-cost assessment after the claim?

Yes. A suitably qualified professional may be able to provide a current or retrospective reinstatement-cost assessment. Its value will depend on the methodology, assumptions and evidence used.

Does index linking prevent commercial property underinsurance?

Not necessarily. Index linking can help account for changes in costs, but it may not correct an inadequate starting valuation. The particular policy wording and declared value still need to be checked.

Could my insurance broker be responsible for an inadequate sum insured?

Possibly, depending on the broker's agreed role, the information supplied by the business and the advice or recommendations given. Broker responsibility should be assessed separately rather than assumed.

What should I send IDS for an initial review?

Start with the policy schedule and wording, the insurer's underinsurance calculation, the rebuild-cost assessment it relies upon, any earlier valuations and the main proposal, renewal and broker correspondence.

Official sources and further reading

This article provides general information, not legal, valuation or financial advice. Reinstatement values, policy interpretation, underinsurance calculations, complaint eligibility and available remedies depend on the individual policy and circumstances. No particular outcome or increase in settlement can be guaranteed.

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