David Thomas discusses underinsurance in the SME sector in Insurance Day
SMEs and the variety of insurable risks – resolving underinsurance in the SME sector
Over the past few months, there has been a substantial amount of mainstream press attention on the problem of underinsurance in the small and medium enterprise (SME) sector. Such attention follows on from polling conducted by the insurer RSA, which revealed that 58 per cent of SMEs were not insured against their top three self-perceived risks and that underinsurance in the SME sector was a concern for 88 per cent of brokers.
RSA’s findings echo research undertaken by the Financial Conduct Authority (FCA), which showed underinsurance to be pervasive in the SME sector. A review of claims made by SMEs found that, in nearly a quarter of cases, the sums insured proved to be inadequate to cover the actual loss suffered.
The fact that there is a problem of underinsurance in the SME sector will not come as a surprise to those working in insurance litigation. It is not hard to see why underinsurance presents a particular problem for SMEs. SMEs face a variety of insurable risks (including loss, theft and damage to property and stock, business interruption, cyber threats, employers’ liability, public liability and professional indemnity/D&O claims), potentially as wide ranging as those faced by larger enterprises. However, unlike larger enterprises, SMEs tend not to have a specialist insurance function and may lack the time, resources and expertise to correctly assess their insurance needs or the resources available.
As such, SMEs may fail to obtain the correct insurance for risks that their business faces. For example, SMEs may be unaware of the existence of specialist cyber risks or directors and officers liability (D&O) insurance. Alternatively, SMEs they may fail to purchase adequate cover. A prime example is business interruption cover, where SMEs routinely underestimate the time taken to reinstate their business following property damage.
SMEs are vulnerable in the event of an underinsured loss. RSA found that, if faced by an uninsured loss of £50,000, over 40 per cent of SME respondents said that they would either go out of business or that they did not know what they would do. Considering the many ways in which a loss or liability of £50,000 could be incurred, underinsurance presents an existential threat to many SMEs.
The problems caused by underinsurance are not restricted to SMEs. They lead to insurers receiving inadequate premiums for the risks insured, and can also cause disputes and litigation between SME policyholders and their insurers, such as:
- Coverage disputes where the SME had failed to take out the specific insurance designed to meet their needs, but now contends that the wording of a policy they did take out is broad enough to respond to a particular claim. For example, attempts are sometimes made to stretch the wording of professional indemnity policies to cover D&O or public liabilities. This could have been avoided if the appropriate suite of cover had been obtained in the first place.
- Disputes about the adequacy of the sum insured in partial loss claims due to the operation of ‘average’ clauses. SME insureds seeking to avoid a proportional reduction in their indemnity under an average clause will often argue that they were not underinsured on a total loss basis, which may be challenged by their insurer.
- Insurers may attempt to avoid policies on the basis that the underestimation of the sums insured was so great that it constituted a material misrepresentation by the SME. There is likely to be a debate as to whether (and when) an underestimation of the sums insured will constitute a breach of the duty to make a fair presentation of the risk under section 3 of the Insurance Act 2015. Moreover, there is an argument to be had as to whether the presence of an average clause within the policy constitutes a waiver of the insurer’s right to ever avoid the policy for underinsurance.
Such disputes are not only costly and time-consuming for both SMEs and insurers, but they also sour the commercial relationship between the parties and prevent the efficient handling of the underlying claim.
Brokers may also be in the firing line if an SME is underinsured. Brokers generally owe their clients a duty to ascertain their insurance needs either by instruction or by undertaking reasonable enquiries (see the case of Youell v. Bland-Welch). A broker who fails to advise an SME on obtaining appropriate or adequate insurance may be vulnerable to a professional negligence claim if a claim is avoided or reduced by an insurer for underinsurance.
Given the FCA’s concern about the underinsurance of SMEs and the recent press attention, eyes are on the industry to see how it will respond. The response appears to be twofold.
First, an education programme on the range of insurance products available, the importance of obtaining adequate cover and of increasing that cover as their business evolves is crucial for SMEs. Brokers are vital and the British Insurance Brokers’ Association (BILA) has published helpful guidance for SMEs on “How to Avoid Under-Insurance”. However, given that many smaller businesses purchase policies directly online, the dissemination of information should go further than the broker network. Websites selling policies to SMEs could offer stronger prompts to information about the range of policies available and how limits of indemnity should be calculated.
Second, changes to the terms of SME policies to reduce the risk of underinsurance. In February 2016, Allianz SE removed average clauses from its core SME products. Insurers may also want to reconsider the minimum levels of cover offered to SMEs. BILA recommends that business interruption cover for SMEs should have a minimum indemnity period of two years and that SMEs should consider declaration-linked insurance. Rather than leaving these types of decisions purely to the SME at time of purchase, insurers may wish to set their minimum cover at a level which reflects BILA’s advice.
From a lawyer’s perspective, if the insurance industry can reduce the rate of underinsurance in the SME sector it should be reflected in a reduction in litigation. Although that will be bad news for lawyers, it would be good news for insurers and their SME policyholders.
This article was originally published in Insurance Day and can be accessed here, behind a paywall.