Short term insurance: Consequences of being over or underinsured

Some people believe in short term insurance, others don’t. If you do believe in taking out short term insurance, make sure that your assets are not over or underinsured. If your assets are overinsured, it means you pay unnecessary premiums for insurance cover you will not be able to claim for. If you are underinsured, you think you are covered for a certain amount while in actual fact you are not covered as well as you think you are.

Overinsurance

Let’s look at Mary’s case:

Ten years ago, Mary bought and insured her car at its then market value of R50 000. Although the market value of her car decreased over time, she never informed her insurance company.

Yesterday she had an accident and wrote off her car. She puts in a claim at her insurance company for R50 000 because that’s the amount her car was insured for.

As the car was insured at market value, the insurance payout is based on the current market value of the car. At the time of the accident, the car’s market value was only R10 000.

Mary is very unhappy because she paid premiums on a market value of R50 000 and now she only received R10 000 from the insurance company.

What happened here?

Mary was overinsured because her car was insured for more than its market value. It was her responsibility to contact her insurance company from time to time to adjust the insured value of her car downwards as its market value had decreased over the years. As the car’s insurance premium was based on its market value, her premium would have reduced every time she informed her insurance company to adjust the market value of her car downwards, and she wouldn’t have paid for more than the amount she was insured for.

Underinsurance

Now let’s look at John’s case:

He originally bought his house for R50 000 and insured it at its then market value of R50 000. Ten years later disaster struck and the house burnt down. At the time of the fire, the house is worth R100 000. However, John never let the insurance company know that the market value of his house increased over the years.

John puts in a claim at his insurance company for R100 000 but the insurance company pays out only R25 000 to settle his claim of R100 000.

What happened here?

The insurance company calculated the ratio between the value John insured his house for and what it was worth at the time it burnt down as follows:

Value insured / Current market value = R50 000/R100 000 = 50%

The ratio of 50% means that the house was insured for only half of its market value of R100 000 at the time of the fire.

Then the insurance company applied the pro rata ratio of 50% to the amount actually insured to calculate the amount of the insurance payout as follows:

Amount insured x Ratio underinsured = R50 000 x 50% = R25 000

If John contacted his insurer from time to time to increase the insured amount of the house to the actual market value, the insurance cover on his house would have been in line with its actual market value of R100 000 when his house burnt down. His premiums would have increased over time to reflect the increase in the insured amount.

Both the above scenarios illustrate the same point: it is crucial that your insurance company have accurate and up to date information on which to determine the amount of your insurance cover and premiums. Ultimately it is your responsibility to keep an eye on the market value of your assets and inform your insurer of any changes in market value that would require an adjustment in the insured value of an asset.

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

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Accessed on 18 September 2015

• SAIA Consumer Education Booklet written by Denis Beckitt