Estimated reading time: 8 minutes
TL;DR
- Underinsurance means your policy payout gets cut, even on a partial loss, if your sums insured don’t reflect what things actually cost today.
- Construction costs have risen more than 31% since the onset of COVID, according to CoreLogic’s Cordell Construction Cost Index (CCCI, 2025), meaning building sums insured set in 2020 or 2021 are likely now understated.
- The averaging clause is the mechanism that reduces your payout. Most business owners don’t know it exists until they make a claim.
- In our experience, Business Interruption is one of the most commonly underinsured covers for SMEs. Revenue grows, the policy doesn’t.
- Fixing it takes 30 minutes with your broker. Not fixing it can cost you hundreds of thousands at claim time.
Table of Contents
What is underinsurance?
Underinsurance means the amount you’re insured for is lower than what it would actually cost to replace or rebuild what you’ve covered.
Think of it this way: you take out a policy, nominate a dollar figure, called your sum insured, and pay premiums based on that number. If you ever make a claim, your insurer pays up to that amount.
The problem is when that number is too low. And in Australia right now, for a lot of businesses, it is.
Most business owners discover they’re underinsured at claim time. That’s the worst possible moment to find out.
How does the averaging clause work… in plain English?
The averaging clause is the policy provision that actually reduces your payout when you’re underinsured. It’s standard in most property and Business Interruption policies, and most people have never heard of it.
Here’s the simplest way to understand it:
If you’re only insured for 70% of what something is actually worth, your insurer will only pay 70% of any claim, even a partial one.
It’s not just about total write-offs. A partial fire, a flood, a theft, the averaging clause applies to all of them if your sum insured is too low.
The formula
Your payout = (Your sum insured ÷ True replacement value) × Claim amount
That probably still looks like a maths problem. Here’s what it means in practice.
Examples
Example 1: The partial fire
Imagine you run a café. Your fit-out and equipment would cost $600,000 to replace today. But when you took out your policy three years ago, you nominated $400,000 as your sum insured because that’s roughly what you spent at the time.
A fire breaks out in the kitchen. It’s not a total loss, the damage is assessed at $180,000.
Here’s what happens:
| Item | Amount |
|---|---|
True replacement value | $600,000 |
Your sum insured | $400,000 |
You’re insured for | 67% of true value |
Fire damage | $180,000 |
What you actually receive | $120,000 |
Gap you absorb | $60,000 |
You’ve been paying premiums faithfully. You didn’t cause the fire. Your claim is completely legitimate. And you’re still $60,000 out of pocket because the averaging clause applied.
Example 2: Business Interruption
You run a marketing agency. Three years ago your annual revenue was $400,000 so you set your Business Interruption sum insured at $400,000. Since then the business has grown, you’re now turning over $700,000 a year.
A flood forces you to close for four months. Your accountant calculates the lost gross profit and fixed costs at $280,000.
| Item | Amount |
|---|---|
True annual gross profit + fixed costs | $700,000 |
Your BI sum insured | $400,000 |
You’re insured for | 57% of true value |
Assessed loss | $280,000 |
What you actually receive | $159,600 |
Gap you absorb | $120,400 |
Your business grew. Your policy didn’t keep up. The result is a six-figure gap at the moment you can least afford it.
Why is underinsurance so common right now?
Several things converged since 2021 to make underinsurance a widespread problem across Australian businesses.
According to CoreLogic’s Cordell Construction Cost Index (CCCI), construction costs rose 7.3% in 2021 alone, the highest annual rate since 2005, then 11.9% over the 12 months to December 2022, the largest annual increase ever recorded. Total cumulative growth since the onset of COVID now sits at more than 31%. The Australia Institute estimated in 2025 that approximately 1.4 million Australian homes were already uninsured or underinsured and that figure doesn’t account for the business insurance gap, which Pocket sees regularly in SME coverage reviews.
| Factor | What’s changed |
|---|---|
Construction costs | Up more than 31% since COVID onset — CoreLogic CCCI, 2025 |
Equipment and IT | Supply chain pressure drove replacement costs higher |
Business revenue growth | BI cover set in 2020–21 is now materially understated for most growing businesses |
Rebuild timelines | Supply chain pressures have eased since 2022, but commercial rebuild times remain longer than pre-COVID norms |
The maths is straightforward: if your business has grown 30% but your insurance hasn’t moved, you’re carrying 30% of your own risk at claim time.
Sources: CoreLogic Cordell Construction Cost Index (CCCI), 2025; Australia Institute, Polling – Home & Contents Insurance, 2025.
The three biggest underinsurance traps
Trap 1: Building sum insured based on market value
The mistake: Insuring a building at its market value or purchase price instead of its replacement cost.
Why it matters: Market value is what your building would sell for. Replacement cost, what it would take to demolish and rebuild from scratch at today’s prices, is often significantly higher, given the 31%+ cumulative rise in construction costs since COVID.
What to do: Commission a reinstatement valuation from a quantity surveyor. This is the figure your insurer needs, not a market appraisal.
Trap 2: Business Interruption cover that hasn’t grown with the business
The mistake: Setting your BI sum insured at launch or last renewal and never adjusting it as revenue grows.
Why it matters: BI pays your ongoing fixed costs and lost gross profit while you can’t trade. If your revenue has doubled but your sum insured hasn’t moved, you’re severely underinsured on the most expensive type of claim a business can face.
Two things to check:
- Sum insured: Should reflect your current annual gross profit plus fixed costs like wages, rent, loan repayments
- Indemnity period: How long cover pays out. Pocket recommends a minimum of 18–24 months for most SMEs, given commercial rebuild timelines
Trap 3: Contents and stock not updated after growth
The mistake: Setting stock and contents values at inception and never revisiting them.
What to do: For seasonal businesses, your sum insured should reflect your peak stock level, not your average. If you’ve bought new equipment, plant, or IT, confirm they’re listed and correctly valued.
How to check if you're underinsured
Work through these questions before your next renewal. Flag any yes answers to your broker.
| Question | If yes, then action is needed |
|---|---|
Has your revenue grown since you last reviewed your BI cover? | Update BI sum insured to reflect current gross profit |
Has your building not been revalued in the last 2 years? | Commission a reinstatement valuation |
Have you bought new equipment, machinery, or IT? | Add to your contents and equipment schedule |
Has your stock level increased? | Update stock sum insured to peak value |
Is your indemnity period 12 months or less? | Discuss whether 18–24 months is more appropriate |
What does fixing it actually cost?
| Review type | Cost | What it does |
|---|---|---|
Broker coverage review | Free | Identifies gaps, updates sums insured, reviews indemnity period |
Quantity surveyor reinstatement valuation | $500–$2,000 (indicative, varies by property size and location) | Confirms correct rebuild cost for your property |
Increasing sum insured by 20% | Modest premium adjustment | Closes a gap that could otherwise cost you hundreds of thousands |
The cost of underinsurance isn’t the premium difference. It’s the uninsured portion of a claim at the worst possible moment for your business.
Frequently asked questions
1. What is underinsurance in Australia?
Underinsurance occurs when your sum insured is lower than the actual cost to replace or rebuild the insured asset. When you make a claim, the insurer applies the averaging clause and your payout is reduced proportionally meaning you absorb part of the loss even though you’re insured.
2. What is the averaging clause?
The averaging clause is a standard policy provision that reduces your payout if you’re insured for less than the true replacement value. If you’re insured for 70% of true value, you receive roughly 70% of any claim on partial losses as well as total ones.
3. Does the averaging clause affect partial claims or only total loss?
Both. It applies to any claim where you’re underinsured like a partial fire, flood, or storm damage. Most business owners assume it only applies if the whole building burns down. It doesn’t.
4. How do I know if my building is underinsured?
If your sum insured is based on purchase price or market value rather than the current cost to demolish and rebuild, you’re likely underinsured. Commission a quantity surveyor’s reinstatement valuation, it’s not a requirement, but it gives you the most accurate rebuild figure and puts you in a much stronger position at claim time.
5. What’s the difference between market value and reinstatement cost?
Market value is what your building would sell for. Reinstatement cost is what it would cost to rebuild it from scratch today including demolition, current construction costs, and professional fees. For insurance, reinstatement cost is the relevant figure and it’s often significantly higher than market value.
6. How often should I review my sums insured?
Annually at minimum, ideally 30–60 days before renewal. Also review mid-year if you’ve had significant changes like new premises, major revenue growth, new equipment or a fitout.
7. What is an indemnity period in Business Interruption insurance?
The indemnity period is how long your BI policy pays out after an insured event. Pocket recommends a minimum of 18–24 months for most SMEs, given commercial rebuild timelines and the complexity of restoring operations after a major loss.
8. Will my insurer tell me if I’m underinsured at renewal?
Insurers renew based on the declared values you provide. The averaging clause is applied at claim time. Your broker should proactively flag underinsurance risk at renewal, if that’s not happening, it’s worth asking.
9. Is underinsurance common in Australia?
Yes. The Australia Institute estimated in 2025 that approximately 1.4 million Australian homes were uninsured or underinsured. The Insurance Council of Australia notes that underinsurance is unfortunately common across Australia, compounded by the sharp rise in construction costs, and equipment prices since 2021. (Sources: Australia Institute, 2025; Insurance Council of Australia)
Related guides
Is your cover keeping pace with your business?
Underinsurance is almost always unintentional and almost always fixable. Pocket reviews your coverage at every stage of growth to make sure your sums insured reflect where your business actually is today, not where it was three years ago.
Book a free coverage review with Pocket →
Call: 1300 475 092 | Email:hello@withpocket.com.au
With Pocket is a business name of Insurance Services Holdings Pty Ltd (ABN 36 612 629 295, AFSL 491165). Member of NIBA and part of the Steadfast Group. This article is general in nature and does not constitute financial advice. Consult a licensed broker for advice specific to your circumstances.
Sources: CoreLogic Cordell Construction Cost Index (CCCI), 2025; Australia Institute, Polling – Home & Contents Insurance, 2025; Insurance Council of Australia, The Risk of Underinsurance (insurancecouncil.com.au); Pocket broker experience.
