Underinsurance Explained: Why Claims Payouts Fall Short

Key things to know

1. Underinsurance means your sum insured is lower than the true cost of rebuilding your home or replacing your contents.
2. If your policy includes an average clause, your insurer can reduce a payout in proportion to how underinsured you are.
3. The buildings sum insured should reflect rebuild costs, including demolition and debris removal, not your home’s market value.
4. The Financial Ombudsman Service sees complaints where payouts were cut because policyholders underestimated rebuild or contents values.
5. Review your sum insured at renewal, and after extensions, renovations or big purchases.

Being underinsured means having a sum insured that is lower than the real cost of rebuilding your home or replacing your belongings. Many people only discover the gap when they claim, and by then it can be expensive. This guide explains how insurers handle underinsurance, how the average clause works, and the checks you can make before renewal.

What Underinsurance Means

When you take out home insurance, you set a maximum amount the insurer will pay, called the sum insured. For buildings cover, this usually means estimating the cost to rebuild your home. For contents cover, it means estimating what it would cost to replace everything you own. The Financial Ombudsman Service notes that this can be difficult to do, and that if the sum insured is too low, insurers may not pay a claim in full, or may not pay it at all.

Underinsurance complaints the ombudsman sees include people who believed they had insured for the right amount, people who accept they were underinsured but disagree about by how much, and people who felt the information at the point of sale was unclear.

How the Average Clause Reduces a Payout

Many home policies contain a term known as the average clause. If you have insured something for less than its replacement value, the insurer can use a formula to pay only a proportion of the loss, leaving you to cover the rest.

A published ombudsman case study shows how this works. A policyholder claimed for water damage and said his rebuild cost was £400,000. The loss adjuster put the true figure nearer £800,000. Because the property was insured for half its rebuild cost, the insurer applied the average clause and settled the claim at 50 percent of its full value. In that case, the policyholder had based his figure on what a neighbour had paid for a similar house the year before, rather than on a rebuild estimate. The ombudsman agreed the estimate was not reasonable, though it did direct the insurer to settle at 85 percent rather than 50 percent, because the premium paid had reflected the lower figure.

The lesson is not that underinsurance always halves a payout. Outcomes depend on how the question was asked, what guidance the insurer gave and the specific policy terms. But the gap between the sum insured and the true value directly shapes what you receive.

Watch for: If your policy includes an average clause, every pound your sum insured falls short can reduce your payout by the same proportion. Check the figure before you buy or renew, not after a loss.

Why the Buildings Sum Insured Is Not the Market Value

A common mistake is assuming the buildings sum insured should match what your home would sell for. It should not. The reinstatement value is what it would cost to rebuild your home from scratch in its current location if it were destroyed, for example by fire. Market value is often much higher than the reinstatement value, because it includes the price of the land.

The rebuild figure also needs to cover more than the structure itself. Council guidance on reinstatement exercises describes assessments that account for the full cost of rebuilding, and leasehold guidance notes that reinstatement value includes permanent fixtures and fittings such as kitchens, bathrooms and fixed flooring. If you have installed high-end versions of these, your sum insured may need to increase.

Checking Your Rebuilding Cost and Contents Value

There are several ways to arrive at a sensible figure:

• Use a reinstatement calculator. The Building Cost Information Service (BCIS), part of RICS, publishes a residential reinstatement calculator that insurers and consumers can use to estimate rebuild costs. It is regularly reviewed and updated.
• Ask a surveyor. Reinstatement cost assessments are covered by an RICS professional standard, reissued in June 2024, which sets out how surveyors should approach and calculate these assessments. Councils use RICS surveyors for exactly this purpose when reviewing the insured value of their housing stock.
• Walk through your home room by room for contents, adding up replacement costs rather than second-hand values, and remember lofts, garages and sheds.

What Happens at Claim Time If You Are Underinsured

If you claim, your insurer may send a loss adjuster to inspect the damage and verify the figures behind your policy. If the sum insured turns out to be too low, the insurer can apply the average clause where the policy allows it. The ombudsman notes it also sees complaints where insurers applied an average clause when the policy contained none, or applied it after failing to ask the customer to estimate the full value of the building or contents, so the details matter.

If you believe a reduced payout is unfair, complain to your insurer first. If you do not receive a final response within eight weeks, or you are unhappy with it, you can bring the complaint to the Financial Ombudsman Service, which weighs the evidence from both sides.

How to Put It Right Before You Renew

Review your sums insured at each renewal, and sooner if you have built an extension, replaced a kitchen or bathroom, or acquired valuable items. Use a current calculator or a professional assessment rather than a neighbour’s sale price or an old figure. Make sure you understand what the insurer is asking for, and if a form is unclear, ask before you answer. Our guides to buildings and contents cover and how loss adjusters work explain more about what each part of a claim involves.

For the wider claims process, see our step-by-step guide to making an insurance claim, and if a payout has already been reduced, our article on rejected and disputed claims sets out your options.

Questions answered

What is the average clause in home insurance?
It is a policy term that lets the insurer reduce a payout when you are underinsured. The payout is cut by the same proportion as the shortfall in your sum insured.

Should my buildings sum insured match my house price?
No. It should reflect what it would cost to rebuild your home from scratch, including demolition and clearing the site, which is a different figure from market value.

Can I complain if my claim is reduced for underinsurance?
Yes. Complain to your insurer first, and if you are unhappy with the response or do not receive a final response within eight weeks, you can take the case to the Financial Ombudsman Service.

How often should I check my sum insured?
A sensible habit is to review it at every renewal, and sooner if you have built an extension, renovated a kitchen or bathroom, or bought items of significant value.