What is 'underinsurance', and how does it affect claims?

Underinsurance refers to a situation where the insured has inadequate cover to fully compensate for a loss. When a property or asset is insured for less than its actual value, or less than what would be necessary to replace it in the event of a claim, it can significantly impact the claims process.

In the event of a loss, if the amount of insurance coverage is lower than the value of the loss, the insurer will base the payout on the proportion of coverage relative to the total value. This means that the claim payout will be less than the actual loss incurred, leaving the insured to cover the difference out of pocket.

Understanding underinsurance is critical for policyholders to ensure that they carry sufficient coverage in line with their actual assets and potential risks. This concept indicates the importance of adequately assessing the value of items to be insured, as it directly correlates to the effectiveness and sufficiency of the insurance policy in times of need.