Business insurance is bought once and then renewed, and the renewal is normally an exercise in comparing the premium to last year's premium. The sums insured — the numbers that actually determine what you get back — carry forward unexamined for years, because nobody sends a prompt to revisit them and the broker's renewal invitation reproduces whatever was there before.
This produces the most frustrating outcome in commercial insurance: a valid claim, on a live policy, settled at a fraction of the loss. Not refused. Reduced. And the mechanism that reduces it is entirely legitimate, disclosed in the policy, and almost never explained at the point of sale.
The clause called average
Most commercial property and contents policies contain a condition of average. It says, in effect, that if the sum insured is less than the true value of what is insured, the insurer will pay the same proportion of any claim as the sum insured bears to the true value.
Illustrative figures. A business insures stock, fixtures and equipment for £60,000. The actual replacement cost of everything on the premises is £100,000. The sum insured is 60% of the true figure. A fire causes £30,000 of damage — well within the £60,000 limit, so the policyholder assumes it is covered in full. Average applies, and the settlement is £18,000.
Being underinsured does not just cap the largest claim you might make. It reduces every claim you make, including the small ones.
That is the part that surprises people. Underinsurance is generally understood as a ceiling problem — insure for less and you get less at the top. In reality, average makes it a percentage problem across the whole policy. A business insured at 60% of value has effectively bought 60% of an insurance policy, and pays a proportionate share of every loss for as long as the sums insured stay wrong.
Where the numbers drift
Three drifts account for most of it, and each is invisible year to year.
Buildings are insured for rebuild cost, not market value, and the two are unrelated. Rebuild cost includes demolition, site clearance, professional fees, compliance with current building regulations, and the fact that reconstructing a single damaged building costs far more per square metre than building an estate of them. Construction costs have moved substantially since 2020, and a figure set before that has not moved with them.
Stock and equipment grow quietly. A business that has expanded its range, taken on a second machine or simply held more stock than it did three years ago is insured for the business it used to be. Anyone whose working capital is tied up in inventory should check that figure against the balance sheet — the cash that's sat on your shelves doing nothing is also the cash that needs insuring.
And reinstatement versus indemnity is a choice that is easy to make wrongly. A reinstatement basis replaces old with new. An indemnity basis deducts wear and tear, so a ten-year-old commercial oven is settled at what a ten-year-old commercial oven is worth, which is nothing like what replacing it costs. Both are legitimate; only one lets you carry on trading.
The cover people forget entirely
Business interruption is where the real damage sits, and it is the least understood section of any commercial policy.
Two things go wrong. The indemnity period is usually set at twelve months by default, and twelve months is frequently nowhere near long enough. A serious fire involves loss adjusters, planning, contractors and refit before the doors reopen, and then a further stretch before trade returns to where it was. If the indemnity period expires while the business is still rebuilding, cover simply stops. For anything involving planning permission or a specialist fit-out, twenty-four or thirty-six months is a more realistic setting.
The second is the definition of gross profit. In a business interruption policy, gross profit is not the figure your accountant puts in the accounts. It is turnover less genuinely variable costs — and many costs an accountant treats as cost of sales continue during a closure. Insure the accounting figure and you have systematically underinsured the thing the policy exists to protect.
Conditions, warranties and the duty to be straight
Two further traps are worth knowing about. Policy conditions and warranties are the operational promises you make: that the alarm is set when the premises are unoccupied, that fire extinguishers are serviced annually, that keys are not left on site, that a specified lock standard is fitted. Breach of a condition precedent to liability can defeat a claim entirely, and the breach is often trivial in itself and discovered only during the claim.
And under the Insurance Act 2015, commercial policyholders owe a duty of fair presentation: disclosing every material circumstance you know or ought to know, in a reasonably clear way. The Act replaced the old all-or-nothing consequence with proportionate remedies, so an innocent non-disclosure that would have led to a higher premium typically results in a proportionately reduced settlement rather than a void policy. That is a considerable improvement on the previous regime, and it is still a reduction in what you get paid.
The renewal that takes an hour
Once a year, do this properly rather than comparing premiums. Get a current rebuild valuation if you own the building or are responsible for it under a full repairing lease. Recalculate stock and equipment at today's replacement cost, not at what you paid. Confirm whether you are on a reinstatement or indemnity basis and make that a decision rather than an inheritance.
Then work out honestly how long it would take to reopen after a total loss, and set the business interruption indemnity period to that plus a recovery margin. Check the gross profit definition your policy uses against your actual cost structure. Read the conditions and warranties and make sure the operational promises match what your business genuinely does every day, because a promise nobody keeps is worse than no cover at all.
Ask your broker one question in writing: if I had a total loss tomorrow, would average apply. A broker who cannot answer that clearly is not the broker you want holding the file when it happens. Insurance sits with employers' liability — what you legally need the day you hire someone — as one of the few costs where the cheapest option and the right option are rarely the same thing.
Common questions
What does the condition of average mean in a business insurance policy?
It means the insurer pays claims in the same proportion that your sum insured bears to the true value of the property insured. If you insure stock and equipment for £60,000 when the actual replacement cost is £100,000, you are insured for 60% of the value, and a £30,000 claim settles at £18,000 even though it is well within the policy limit. The important consequence is that underinsurance is not only a ceiling on large claims — it proportionately reduces every claim, including small ones, for as long as the sums insured remain below the real figure.
Should I insure my building for its market value?
No. Buildings insurance is based on rebuild cost, which is a different figure from market value and frequently a higher one. Rebuild cost has to cover demolition and site clearance, professional and surveyor fees, compliance with current building regulations, and the higher per-square-metre cost of reconstructing a single damaged building rather than developing several at once. Construction costs have moved considerably since 2020, so a sum insured set before then is likely to be materially out of date. If you own the premises or are responsible for them under a full repairing lease, a professional rebuild valuation is worth commissioning.
How long should my business interruption indemnity period be?
Long enough to cover the full time from the loss to the point trade returns to where it was, which is almost always longer than the twelve-month default. A serious fire involves loss adjusters, planning consent, contractors and a refit before the doors reopen, and then a further period before customers come back. If the indemnity period expires while you are still rebuilding, the cover simply stops paying. For premises needing planning permission or a specialist fit-out, twenty-four or thirty-six months is a far more realistic setting, and the extra premium is small relative to the exposure.
Can an insurer refuse a claim because I did not tell them something?
Commercial policyholders owe a duty of fair presentation under the Insurance Act 2015, meaning you must disclose every material circumstance you know or ought to know, presented in a reasonably clear and accessible way. The Act replaced the old all-or-nothing rule with proportionate remedies, so an innocent failure to disclose something that would have led to a higher premium normally results in a proportionately reduced settlement rather than the policy being voided. Deliberate or reckless non-disclosure can still allow the insurer to avoid the policy entirely and keep the premium, so disclose anything you are unsure about.
