Research in the current market has found that a large share of commercial properties are underinsured, in many studies more than 40% of them, by an average shortfall of over 40% against their true rebuild cost. Put plainly: a great many owners are carrying roughly half the cover they think they have, and most won't discover it until they claim.
Underinsurance is when a property's sum insured is lower than the cost to reinstate it, and because most property policies apply a condition of average, it can scale down even a partial claim, not just a total loss.
This is a board-level issue, not a technical one, and it's got worse fast. This guide explains why construction cost inflation has pushed sums insured below rebuild cost, how the average clause bites, and the difference between reinstatement value and market value that sits at the centre of the problem.
When did you last revalue your portfolio for insurance?
If the answer is more than a couple of years, your sums insured probably no longer rebuild your assets. Emerge reviews reinstatement values and property cover for owners across the region and flags where the shortfall sits.
What underinsurance actually is
Underinsurance is simple to state: the sum insured on a property is less than what it would cost to rebuild it. The reason it's dangerous is that it usually develops invisibly. The policy renews, the premium looks reasonable, and the sum insured drifts further below reality each year that rebuild costs rise and the figure isn't updated.
Rebuild cost is not a static number. It moves with the price of materials, labour, professional fees, demolition and debris removal, and compliance with current building codes. Since 2022, those costs have risen sharply across most markets, driven by materials, supply-chain disruption and labour. A building insured at its 2020 or 2021 figure can easily be underinsured by 30 to 40% today simply because the world got more expensive to build in.
The trap is that nothing signals the problem until a loss. An owner can pay premiums faithfully for years and still be badly underinsured on the day it matters.
The condition of average: the part that surprises people
Most owners assume underinsurance only matters for a total loss, that if the building burns to the ground they'd simply recover up to the sum insured. The more painful reality is the condition of average, and it applies to partial losses too.
The average clause lets an insurer reduce a claim in proportion to the degree of underinsurance. If a property is insured for 70% of its reinstatement value, the insurer can cut a claim by roughly 30%, whether the loss is total or partial. So a fire that causes damage well within the sum insured can still be underpaid, because the policy treats the owner as self-insuring the uninsured proportion of every loss.
| Reinstatement value | Sum insured | A partial loss claim of 1.0m may be settled around |
|---|---|---|
| 10.0m | 10.0m (fully insured) | 1.0m |
| 10.0m | 7.0m (70% insured) | around 0.7m |
| 10.0m | 5.0m (50% insured) | around 0.5m |
This table is a simplified illustration of the mechanic, not a specific policy calculation. The exact operation of average depends on the wording. The point stands: underinsurance quietly reduces what you recover on ordinary, everyday losses, which are far more common than total ones.
Reinstatement value versus market value
The most common root cause of underinsurance is insuring on the wrong basis. Owners and their advisors sometimes anchor the sum insured to a market value, a purchase price, or a book value, none of which is what an insurer pays after a loss.
An insurer reinstates the building. So the correct basis is reinstatement cost: what it would take to rebuild the structure today, including professional fees, demolition, debris removal and code compliance. Market value is a different thing entirely, driven by location, rental income and land value, and it can sit well above or well below rebuild cost. A prime asset on expensive land might have a market value far above its rebuild cost, while a specialised building in a soft market might cost more to rebuild than to buy.
Insuring on market value therefore breaks the link to construction costs, which is exactly the link that matters. When rebuild costs inflate, a market-value-based sum insured doesn't follow, and the shortfall grows.
| Common cause | Why it underinsures the asset |
|---|---|
| Insuring on market or book value | Neither tracks the cost to rebuild, which is what the insurer pays |
| Valuation not refreshed | Construction-cost inflation erodes the sum insured every year it's rolled over |
| Fees and demolition omitted | Professional fees, demolition and debris removal are left out of the figure |
| Business interruption undersized | Income sum insured or indemnity period too low for a real rebuild timeline |
Are your sums insured based on rebuild cost or something else?
Market value, book value and an old valuation are the three most common causes of underinsurance. Emerge runs a 30-minute review of how your portfolio's sums insured were set and where they've drifted from current rebuild cost. No obligation follows.
Business interruption: the second, quieter shortfall
Underinsurance isn't only about the building. The business interruption side is underinsured just as often, and in ways that are easier to miss because the numbers are less tangible than bricks.
Two errors recur. The sum insured for gross profit or rental income is understated, so the income cover is too small. And the indemnity period, the maximum time the policy will pay while the business recovers, is set too short to reflect how long a serious loss actually takes to resolve. A full rebuild of a damaged hotel or mall, including design, permitting, construction, re-fit and re-tenanting, can run well beyond a 12-month indemnity period, and income losses after that period simply aren't covered.
This matters for catastrophe-exposed assets in particular, where a major event can extend the rebuild timeline. It sits alongside the natural catastrophe question: the right property limit and a too-short indemnity period still leave the income exposed.
How owners close the gap
Fixing underinsurance is not complicated, but it does require doing the work rather than rolling figures over. The steps are well established.
| Step | What it does |
|---|---|
| Professional reinstatement valuation | Sets an accurate rebuild-cost basis for the sum insured |
| Regular revaluation | Keeps the figure aligned as construction costs rise |
| Index-linking of the sum insured | Adjusts cover for inflation between valuations |
| Realistic business interruption period | Matches the indemnity period to a real rebuild timeline |
| Renewal review | Confirms values before each renewal rather than after a loss |
Insurers are increasingly insisting on this. Carriers are requiring updated appraisals and tightening terms around valuation, and a well-documented valuation also strengthens your position at renewal. Across a portfolio, this is one of the highest-return pieces of risk hygiene available, because it protects the recovery on every future claim.
FAQ
What is underinsurance in commercial property?
Underinsurance is when a property's sum insured is lower than the cost to reinstate it. It usually happens because rebuild costs rise over time while the sum insured is left unchanged. The result is that a claim, even a partial one, may not be paid in full, because most property policies apply a condition of average that scales the payout to the level of insurance carried.
How does the condition of average work?
The condition of average, also called the average clause, reduces a claim in proportion to how underinsured a property is. If a building is insured for only 70% of its reinstatement value, the insurer can reduce a claim by roughly the same proportion, so even a partial loss isn't paid in full. It applies to routine losses, not just total losses.
Should a building be insured for market value or reinstatement value?
Property should generally be insured for reinstatement value, the cost to rebuild it, not market value. Market value reflects location, income and land, and can be far higher or lower than rebuild cost. Insuring on market value is a common cause of underinsurance because it doesn't track construction costs, which are what an insurer pays to reinstate.
Why has underinsurance become worse recently?
Construction costs have risen sharply since 2022 due to materials, labour and supply-chain pressures, while many sums insured weren't updated to match. Research has found a large share of commercial properties underinsured, often by 30 to 40% or more. Insurers are now requiring updated valuations and tightening terms in response.
How can a property owner avoid underinsurance?
The main step is a professional reinstatement-cost valuation, refreshed regularly rather than rolled over. Owners can also use index-linking to adjust the sum insured for inflation, day-one uplift provisions, and a realistic business interruption indemnity period. Reviewing valuations at each renewal keeps sums insured aligned with rising rebuild costs.
Does underinsurance affect business interruption cover too?
Yes. Business interruption is commonly underinsured when the sum insured for gross profit is understated or the indemnity period is too short to reflect how long a full rebuild and re-tenanting would take. A property can be correctly valued for rebuilding and still leave the owner exposed on the income side if the business interruption cover isn't sized properly.
Emerge Conclusion
Underinsurance is the rare risk that costs nothing to fix and everything to ignore. Construction cost inflation has quietly pushed a large share of commercial property below the cover needed to rebuild it, and the condition of average means that shortfall reduces the recovery on ordinary losses, not just catastrophic ones.
The question to put to your own portfolio is whether the sums insured are based on a current reinstatement valuation, or on a market value or a figure that hasn't moved in years. If it's the latter, a valuation review is the single highest-return action you can take before your next renewal.
Request a valuation and cover review from the Emerge team →
Disclaimer: This article provides general guidance on property insurance principles as of July 2026. The operation of the condition of average, valuation bases and policy terms varies by wording and carrier. Figures cited are drawn from published industry research and are illustrative. Always review specific policy wordings and obtain a professional valuation and qualified broking advice before making coverage decisions.
