Risks of being underinsured: Do you know the implications?

George Davis, Divisional Head at RBS.

Local consumers are traditionally underinsured – a critical oversight that only gets worse during tough economic times, especially in light of the recent announcement by the SA Reserve Bank's Monetary Policy Committee last week. While there was no change to the interest rate in May, it was reported that this is merely a pause and not a reversal, indicating that consumers should brace for a further rate hike.

As consumers grapple with debt and the cost of living – with an estimated 10.3 million South Africans battling to meet their monthly debt repayments, according to the National Credit Regulator – insurance and risk related expenditure is often the first expense to be cut in household budgets. But when trying to cut short-term costs, consumers may actually find themselves in more financial trouble should the unforeseeable occur, says George Davis, Divisional Head at Risk Benefit Solutions (RBS).

Recent research by Octogen revealed that, over the past 15 years, consumers average spend on risk services has dropped from 23% to 17%. But more alarming, is that 34% of consumers don’t have short-term insurance.

As disposable incomes experience increased pressure from rising food, fuel and electricity prices, Davis sympathises when clients try to minimise insurance costs where they can. “While there is always the temptation to cut insurance costs, consumers need to review their policies with their brokers, to prevent being exposed to financial loses as a result of being underinsured.”

A common misconception held by consumers is that the premium linked to an insured asset should decrease over the lifespan of the asset. Logically, this makes sense: as an asset gets older, it depreciates and becomes less “valuable”. However, Davis explains that after taking inflation and market conditions into account, this is not always the case. He adds that the basis of how the product / item will be re-instated, such as new for old, also needs to be taken into account.

“The value of an insured asset that is either imported or includes any imported parts will be susceptible to the value of the rand. The cost to replace the asset may be substantially higher today than it was when the asset or parts were purchased, given the rand’s weakening performance over the past few months. In the event of a claim, a client may then find out that they are only partially covered, because of what insurers call ‘the rule of average’.”

He goes on to explain this rule as follows: “If household contents are insured for R200 000, but the actual replacement value for these assets is now double that, the client would effectively be 50% underinsured. In the event that the client has a claim, the insurer may only pay 50% of the claim. This means that for a claim of R10 000, the client would only get R5 000 paid and then be out of pocket for the remaining R5 000.

“Consumers therefore need to ensure that the sum they are insured for, is for the new replacement value of the items.”

When it comes to property, Davis warns that homeowners are at an even bigger risk of being underinsured. “People make the mistake of insuring their home for the value that they purchased the property for, but home insurance should actually be based on what it would cost to rebuild the property today. Even in the case that a property has been insured at current market value, the actual costs that would be incurred to rebuild the house could have appreciated well beyond the cover value. This insurance should therefore be reviewed annually as one would for car insurance.”

Davis adds that it is also important that consumers update their home insurance policy after any renovations have been done. “Any renovations or home improvements will naturally increase the market value of the property and, as such, will affect the insured value.”

Consumers need to be aware that the value of items is constantly changing, especially given the recent, somewhat volatile, economic climate. “To avoid being underinsured, we encourage clients to make continuous policy reviews with their brokers in order to assess the potential impact that the depreciated rand, coupled with rising inflation, may have had on the value of their insured assets,” concludes Davis.