Owning commercial real estate is a significant investment. Whether you run a warehouse, office building or retail space, the survival of your business often hinges on your ability to rebuild or trade after a disaster. Insurance is meant to provide that safety net, yet many property owners discover, often after it’s too late, that their cover is inadequate. This guide explains the key issues commercial property owners should look out for, with a focus on underinsurance and business interruption cover. Throughout the article you’ll find real‑world examples and practical tips to help you avoid pitfalls.
Why Underinsurance Is a Critical Risk
Underinsurance occurs when the sum insured under your policy isn’t enough to rebuild or replace the property after a total loss. This can happen because of rising construction costs, outdated valuations and hidden expenses such as demolition, debris removal or compliance with new building codes. When a policy includes an average or co‑insurance clause (which usually occurs when sums insured are less than 80% of the real replacement value), a claim can be reduced in proportion to the level of underinsurance. For instance, if you insure a $1 million property for only $500 000, any claim can be reduced accordingly
Causes of Underinsurance
- Rising building costs. Inflation and supply‑chain disruption have driven up labour and material costs. If your sum insured is based on outdated prices, you could be left short when it comes time to rebuild.
- Outdated or inaccurate valuations. Property owners often neglect to obtain regular professional valuations, so the sums insured fall below true replacement cost.
- Hidden and compliance costs. Demolition, debris removal and the need to meet updated building codes can add hundreds of thousands of dollars to a rebuild.
- Complex properties or tenant improvements. Warehouses and office buildings may include specialised equipment or tenant fit‑outs; failing to insure these items pushes the cost burden back on the owner.
Real‑Life Examples of Underinsurance
| Scenario | Consequence |
|---|---|
| Warehouse underinsured by 33 % | A warehouse insured for $2 million was later valued at $3 million. When a fire caused $100,000 worth of damage, the insurer applied the average clause and only paid 66 % of the claim, leaving the owner with a $200,000 shortfall. |
| Building compliance costs not covered | A commercial office building needed major upgrades to comply with new building codes after storm damage. Because the owner hadn’t factored compliance costs into the sum insured, they faced a significant unexpected bill. |
These examples highlight how underestimating property values or ignoring compliance costs can leave an owner facing major out‑of‑pocket expenses.
Understanding Business Interruption Insurance
Property insurance pays for physical damage, but it doesn’t compensate you for lost income while the business is closed. That’s why Business Interruption (BI) insurance is so important. BI insurance functions like income protection for your business, it covers loss of trading profit and extra expenses incurred to keep the business running after an insured event. Policies typically pay for rent, mortgage repayments, wages, utility bills, loan repayments and the cost of hiring temporary equipment.
Why Business Interruption Matters
- High risk of disruption. Events such as fires, storms, cyber incidents and supply‑chain issues are among the top global risks; the 2023 Global Risk Management Survey ranked business interruption as the second‑highest global risk.
- Large financial impact. According to the Insurance Council of Australia, business interruption claims accounted for 15 % of total business insurance claims in 2022 with an average cost of $17,000. CGU Insurance reported that 81 % of SMEs believe an unforeseen interruption would have a severe impact on their business.
- Low uptake. Despite the risk, a survey by QBE showed that only 17 % of small businesses have a BI policy, while CGU found only 27 % of SMEs held one. Businesses without BI insurance have less than a one in ten chance of survival after a major loss.
Common Pitfalls in Business Interruption Cover
- Inadequate indemnity period. Your indemnity period is the length of time the policy will pay for lost income. EBM Insurance & Risk notes that many businesses underestimate how long it takes to recover; most need at least 18-24 months to rebuild and regain customers.
- Underestimating increased costs of working. To maintain operations after a loss, you may need to rent temporary premises, lease equipment or pay overtime. If these costs aren’t factored into your BI sum insured, you’ll be out of pocket.
- Misunderstanding gross profit calculations. Insurance policies define gross profit differently from accounting standards. When calculating your BI cover, you must use the insurer’s definition and adjust the sum insured to match the indemnity period.
- Buying the wrong type of BI policy. There are several forms of BI cover; loss of gross profit, weekly income, additional increased costs of working and more. An insurance broker can help you choose the appropriate option for your business.
Example: How Indemnity Periods Affect Claims
A B.I. policy’s indemnity period determines how long you receive benefits. In Macey’s example, a busy seaside café with a 12‑month indemnity period suffered a fire that forced the business to shut for three months. The policy covered lost profits up to 12 months from the date of the fire. If rebuilding took longer than a year, perhaps due to labour shortages or approvals, the café would stop receiving payments once the indemnity period expired. This demonstrates why longer indemnity periods are often prudent.
How to Avoid Underinsurance and Gaps in BI Cover
- Get regular professional valuations. Engage a qualified valuer every year or two to ensure your sum insured reflects current replacement costs.
- Include all replacement costs. Ensure your policy covers demolition, debris removal, architect fees and compliance upgrades.
- Use indexation clauses. Policies with indexation automatically adjust the sum insured to reflect inflation and rising construction costs.
- Review your policy annually. Update sums insured after renovations, equipment upgrades or changes in tenancy. Use renewal time to re‑assess business risks and adjust cover.
- Create a business continuity plan. Planning helps you identify potential loss scenarios, determine the correct indemnity period and assess variable costs.
- Calculate gross profit correctly. Work with your accountant and broker to ensure the gross profit figure used in your BI policy matches the policy definition and is multiplied by the indemnity period.
- Select an appropriate indemnity period. Consider worst‑case scenarios; many businesses need 12–24 months to recover. Don’t cut the indemnity period just to save on premium.
- Consult a qualified insurance broker. Brokers can review your policy, conduct sums‑insured assessments and help tailor cover to your business’s unique risks.
Final Thoughts
Commercial property insurance is more than a requirement; it’s a lifeline for your business. The underinsurance crisis in Australia highlights that many property owners may face significant out‑of‑pocket costs if they haven’t updated their sums insured. Combine this with the low uptake of business interruption cover, and it becomes clear that a major loss could threaten the very survival of your business. By understanding how underinsurance works, recognising the importance of BI insurance and taking proactive steps—like regular valuations, detailed continuity planning and working with a trusted broker—you can ensure your insurance will genuinely protect your investment when disaster strikes.
This post highlights the key risks of underinsurance, explains the importance of business interruption cover with real examples, and offers practical tips to ensure property owners have adequate protection. Let me know if you’d like any adjustments or additions!
