The underinsurance crisis: legal repercussions, broker responsibilities, and growing solutions
Underinsurance is still a major, pressing issue in the UK insurance market, with recent figures revealing that a huge 76% of commercial buildings are currently underinsured. While this is an improvement from 81% in 2023 and 83% at its peak, the statistics reveal a systemic issue which affects businesses, policyholders, and every facet of the insurance ecosystem.
In a recent webinar on Underinsurance and the Insurance Act 2015, Alex Rosenfield, Partner at Fenchurch Law, delved into the world of underinsurance, why it’s become such a huge problem for our industry, the remedies that insurers may apply under the Insurance Act 2015, the legal and financial consequences for policyholders and brokers, and finally, some suggested strategies to mitigate the risks of underinsurance.
What is underinsurance?
Taking it back to basics, underinsurance arises when the total sum insured cannot cover the full cost of rebuilding or repairing a property. The gap between the true value, and the insured value can be created for many reasons.
- Failure to factor in full rebuild costs: Including demolition, debris removal, professional fees (e.g. architects and builders).
- Inflation: Rising costs of labour, materials, and equipment may not be reflected in outdated valuations.
- Forgetting VAT: This can be especially problematic for businesses that cannot reclaim VAT.
- Intentional underinsurance: The deliberate choice to disclose lower values to reduce premiums, a risky choice which can have detrimental implications on the policy holder.
Even financially educated clients and policyholders can end up underinsured, and one of the biggest reasons is a lack of diligence.
The implications of being underinsured can be very serious. Insurers tend to apply an average clause, and the policyholder may find themselves in financial crisis, needing to fund the difference between the sums insured, and the true asset value.
Alex stressed, “Underinsurance can be disastrous with large claims, but even partial losses can still leave policyholders under-compensated.”
As an alternative (and potentially in addition) to applying average, the insurer can apply a remedy for a breach of the duty of fair presentation under the Insurance Act 2015 (“the IA 2015”), which will depend on whether the breach was deliberate or reckless, or merely carless. If it was deliberate or reckless, the insurer can refuse to pay the claim, or void the policy altogether.
If this happens, the policyholder would most likely have to share this information with a future insurer, and they may be marked as a ‘moral hazard’, reducing their perceived capacity to suffer a loss of a particular kind.
It could also frustrate business continuity in some cases, as the insured may need to wait for financial stability, and in another commercial sense, beyond the financial hit, the act of underinsuring may put directors in breach of their statutory duties.
Insurer remedies for underinsurance
Alex explained that insurers most commonly utilise one of two remedies:
The Average Clause is the most common contractual remedy, proportionally reducing the claim to discourage underinsurance and reinforce the importance of accurate valuations.
There is also the possibility of the insurer applying a remedy for a breach of the duty of presentation under the IA 2015. If the breach was deliberate or reckless, the insurer can avoid the policy and refuse all claims, and keep the premium. If it was careless or negligent, the insurer’s remedy will be proportionate, and turn on what the underwriter would have done differently had the true insured sums been disclosed.
Can insurers apply both remedies?
Alex addressed a nuanced and (currently) legally untested question: Can an insurer apply both average and a proportionate remedy under the Insurance Act to the same failure?
While technically possible, Alex argued this would likely be seen as commercially unfair and commercially unattractive, creating a double punishment. A more reasonable response, he argues, is a single repercussion based on the circumstances and severity of the breach.
“To my mind, applying both remedies cumulatively doesn't sound very attractive, because policyholders effectively be punished twice for the same failure. I think a better analysis, which I think sounds a lot more commercial, is that the insurer picks one or the other, which may just depend on how this has all happened.”
Declaration-linked and waiver of average cover
Declaration-Linked Cover (a premium based on estimated gross profit), avoids average application, unless dishonesty is involved, and is especially useful for those businesses with changeable values and success. Traditional Sum Insured with Waiver of Average promises full claim payouts without average deductions, which is also ideal for businesses that struggle with accurate valuations. However, with a waiver of average, not disclosing ‘material’ changes, such as business value growth, may still be considered a breach of the duty of fair presentation.
“Average and the remedies that insurers have under the Insurance Act can be targeted for very different things. Where an average deals with inactive, inadequate cover that the insured chooses, which is a contractual term, the values of the Insurance Act address inadequate disclosure, which affect the risk so they do address different things.”
Having covered the insurer’s and policyholder’s responsibilities at length, where does the broker stand, what are their responsibilities?
The broker’s role
Alex went on to highlight the role of the broker in helping clients to mitigate the risk of underinsurance. The Infinity Reliance v Heath Crawford case serves as a significant warning to brokers about the importance of comprehensive client advice and clear communication about insurance terms.
Infinity Reliance, an online retailer, experienced a devastating warehouse fire, but after realising that the business was underinsured, the covered value was only 26% of the actual rebuild cost (which was around £33m). The insurer, Aviva, decided to apply average, leaving the business £3 million out of pocket.
But how was the broker implicated? Infinity alliance sued their broker, Heath Crawford, claiming that he had shared misleading documentation, failed to provide proper advice on the insurance calculation, and that he had not considered the alternative premises and additional costs in his advice.
The court agreed with the policyholder, finding the broker had breached his duty. How?
- Not explaining the potential downsides of the chosen insurance type
- Failing to clarify the implications of average and coverage limits
- Not ensuring that the client’s insurance choice was informed and genuine.
Indeed, while Infinity Reliance expressed that they didn’t want to suffer a premium change, the broker was ultimately in breach of duty, as a reasonable broker would recommend a declaration of cover.
“The broker must ensure the client understands any disadvantageous consequences, such as the risk that underinsurance would lead to any claim being reduced by average... even when a preference isn't expressed, the reasonable broker should check that it remains a genuine and informed choice,” Alex clarified.
Today’s legal landscape and practical solutions
While the Insurance Act 2015 introduced clearer frameworks, case law is still limited, leaving policyholders and insurers uncertain, especially on the potential for “double dipping” and the full implications of negligent misrepresentations.
So, what does Alex suggest to help combat the major issue?
- Address the root cause: diligence
There are many reasons for underinsurance, but there is one key theme amongst all reasons: a lack of diligence. It is of the highest importance to express the need for regular evaluations make sure that the policy covers all the necessary rebuild elements, and also to take account of inflation. It is also imperative that the policy holder reviews these figures annually.
"Never assume that the figures and costs that were adequate yesterday will be relevant today."
- Clarify remedy application
Insurers can, theoretically, apply cumulative remedies to the same ‘failure’, even if it feels “very draconian”. A practical solution is to actually discuss the remedy that might apply with insurers, and in what circumstances. That therefore creates certainty for all parties involved.
- Educate clients thoroughly
Brokers must explain the consequences to the policyholder of not insuring adequately; “It does go about saying that policyholders do need to be aware that other insurance can lead to serious shortfalls, even for partial losses.”
“Concepts such as average or declaration linked cover won't be obvious to everybody, so it is important to make sure that your policyholder clients know precisely what those terms mean.”
Underinsurance is not just a hidden gap in coverage, but a systemic vulnerability that has the capacity to shake business stability. With 76% of buildings underinsured, this is a problem that demands urgent attention from the entire insurance ecosystem: from insurers to policyholders to brokers.
The combined force of regulatory obligations, court decisions like Infinity Alliance, makes it clear: accurate valuation, diligent disclosure, and client education are necessities to combating this widespread issue in the current risk market.
Alex Rosenfield is a Partner at Fenchurch Law
Win-Win, and Win again: Delos Shipholding v Allianz in the Court of Appeal
Introduction
In October 2024, our colleagues Toby Nabarro and Eugene Lee wrote here about the policyholders’ first instance success in the case of Delos Shipholding SA & Ors v Allianz Global Corporate and Specialty SE & Ors [2024]. The Court of Appeal has recently upheld those findings in a judgment which will be essential reading for those involved in coverage disputes, especially concerning the duty of fair presentation under the Insurance Act 2015 (the Act).
Background
The case originated from an incident in February 2019 when the "WIN WIN", a bulk carrier vessel, was detained by Indonesian authorities for anchoring inside Indonesian territorial waters without permission. The vessel was detained for over a year, leading to its classification as a constructive total loss under the terms of the war risks insurance policy issued by the appellant insurers.
Key Issues on Appeal
The insurers were granted permission to appeal on two primary issues:
1. Exclusion Clause Interpretation:
The first issue concerned the interpretation of Exclusion (e) of the American Institute Hull War Risks and Strikes Clauses (1977), which excludes loss caused by, resulting from, or incurred as a consequence of "Arrest, restraint or detainment under customs or quarantine regulations and similar arrests, restraints or detainments not arising from actual or impending hostilities". The insurers argued that the detention of the vessel fell under this exclusion.
2. Duty of Fair Presentation:
The second issue was whether the policyholders had breached the duty of fair presentation under the Act by failing to disclose that the sole director of the registered owner of the vessel was the subject of criminal charges in Greece.
Court of Appeal's Decision
The Court of Appeal unanimously dismissed the insurers' appeal and upheld the policyholders’ claim for an indemnity.
1. The Exclusion:
The Court of Appeal interpreted the exclusion as applying to detentions under two different kinds of regulation, i.e. customs or quarantine regulations, and extending to other regulations with a similar purpose. The reason for the detainment here was because the vessel did not have the correct licence and it was common ground that it had not been detained under any customs or quarantine regulations.
The insurers’ case was that there had been a detention which was “similar” to a detention under customs or quarantine regulations, in part because customs and quarantine regulations are concerned with the exercise of state sovereignty and security, or clearances, and that the regulations under which the arrest was made were “similar”.
The Court found that the exclusion was concerned with:
“Arrest, restraint or detainment under customs or quarantine regulations and similar arrests, restraints or detainments …’ As a matter of strict language it might be said that it is the arrest, restraint or detainment which has to be similar to an arrest, restraint or detainment under customs or quarantine regulations, but as all arrests are similar in that they place a vessel under the control of the arresting state, it is clear that the similarity with which the clause is concerned is whether the regulation under which the arrest is effected is similar to, or has a similar purpose to, a customs or quarantine regulation”
As the detention of the vessel was completely unconnected – on the facts - to customs or quarantine regulations, the Court found that it therefore did not fall under the exclusion.
2. Duty of Fair Presentation:
On the issue of fair presentation, the issue was whether the insureds ought to have disclosed criminal charges which had been brought against its sole nominee director prior to inception of the policy.
The principal insured was Delos Shipholding S.A. (Delos), which was the registered owner of the vessel. Its sole nominee director was a Mr Bairactaris, a Greek maritime lawyer. Delos was part of the NGM Group, a well-known Greek shipping group run by the Moundreas family. Mr Bairactaris was the only person who was aware of the charges which had been brought against him. Mr Bairactaris was limited in his role as nominee director to taking instructions from the Moundreas family, he exercised no independent judgment and made no decisions.
Actual knowledge
As a corporate insured, pursuant to s.4 of the Act, Delos was obliged to disclose material information within the actual knowledge of its “senior management” (or information which Delos “ought to know”, as discussed further below). The first issue was whether Mr Bairactaris fell within the definition of “senior management”, being “those individuals who play significant roles in the making of decisions about how the insured’s activities are to be managed or organised”.
Both Courts found that Delos’ activities consisted of owning and operating the vessel for profit, which included acquiring contractual rights and obligations. Mr Bairactaris played no part in these activities and had no decision-making role; he simply did what he was told by the Moundreas family.
Therefore, the Court of Appeal upheld the first instance finding that Delos was not aware of the criminal allegations that had been brought against Mr Bairactatris. Whilst the sole director of a corporate insured will normally be part of the insured’s senior management, this will not always be the case. Further, it did not follow from this finding that Delos had no senior management for the purposes of the Act; rather, the senior management comprised those members of the Moundreas family who took the decisions on behalf of Delos.
Ought to know
The Court of Appeal also upheld the first instance finding that the criminal allegations did not amount to information which Delos ought to have known pursuant to s3(4)(a). In short, the obligation to make reasonable enquires pursuant to s4(6) did not extend to asking Mr Bairactaris about whether he knew of any material information, essentially because he knew nothing about the vessel to be insured and thus Delos would reasonably have considered it futile to make enquiries of him .
Inducement and remedy
Pursuant to s5, Schedule 1 of the Act, if the insurer would have entered into the contract, but on different terms, the contract is to be treated as if it had been entered into on those terms. The trial judge had found that, upon full presentation of the criminal charges, insurers would have imposed a condition that Mr Bairactaris should resign as a director and that the insured would have complied with that condition because Mr Bairactaris would have resigned (i.e. that the non-disclosure had not, therefore, induced insurers to enter into the policy).
Insurers argued that it was impermissible to consider what the insured would have done in response to any hypothetical additional terms imposed by insurers as this was not provided for in the Act itself; an argument which was supported by the Law Commission Report on the draft Act (para 11.82), which had stated:
”… it should not be open to an insured to say that it would have complied with any term which the insurer would have imposed (for example, an exclusion or warranty) and so the loss should be covered…”
Given the finding that the insureds had not breached the duty of fair presentation, the Court of Appeal stated that it was unnecessary to determine whether the trial judge was wrong in her findings on inducement, although the Court of Appeal said they found insurers’ submissions persuasive. The Court also noted that it had not received any submissions on whether it was legitimate to use the Law Commission Report or Explanatory Notes to the Act as aids to interpretation and made no findings in this regard.
This important issue of inducement will therefore be left to be decided in another case.
Implications of the Decision
The Act is one of, if not the, most important pieces of legislation for policyholders and coverage lawyers. Therefore, any judgment from an appellate Court discussing the Act is essential reading, especially when the policyholders prevailed. The Court of Appeal's decision should be kept in mind, especially in relation to the duty of fair presentation, when considering:
- The circumstances when an individual may or may not form part of the insured’s senior management. Senior management may include individuals who are not on the board, not employees and who have no contract with the insured;
- The extent to which reasonable enquires have to be made of someone within the organisation seeking insurance; and
- Inducement, and the extent to which it may be legitimate to consider steps which the insured would have taken in response to an additional term which the insurer hypothetically would have imposed following fuller disclosure. The Court of Appeal strongly indicated that such an approach was wrong, whilst not making any findings on this point meaning that, technically, this is still an open issue for another day.
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