Why Home Insurance often pays out less than you expect

Steven Mendel By Steven Mendel

There was an article in the Sunday Times recently, entitled ‘Insurers sidestep contents payouts’. In it, Ali Hussain detailed the rising number of complaints that the Financial Ombudsman Service (FOS) has been receiving from policyholders who have been disappointed when their insurers have not paid out in full on a household insurance claim, on the basis that the policyholder wasn’t adequately insured.

To understand the assertion from the insurers it is important to understand a little-known and even less understood insurance phrase called the Principle of Average.

To best explain this jargon, let me show you the consequences of not understanding it:

    1. You have a household contents policy which insures your possessions for, let’s say, £25,000.
    2. You took out the policy a number of years ago and since then the cost of many of your possessions has increased in value (eg gold and silver jewellery), you have also been buying – you now own a large flat screen TV, some Apple kit, a new and expensive lounge suite, as well as many smaller purchases (such as clothing). In fact the total cost of replacing everything you now own is £50,000. Yet your insurance policy is still languishing at £25,000, half the current value.

    So what, you might say, I’m never going to be burgled and loose over £25,000 of my stuff. To understand how an insurer would view this issue imagine the worst happens and you have a fire at home, or simply a burst pipe in loft – even if everything was ruined you are still only insured for £25,000. So the total payout could never be more than £25,000, ie half of what you need. Perhaps more usefully consider that you do have a burglary. You lose £5,000 of your possessions. Your insurer sees that you are underinsured by half and so only can pay you half of what you need to replace the stolen possessions.

    The Principle of Average is very hard to get – in fact some years ago I was marking an actuarial exam that contained a question asking for this concept to be explained. Most of the papers I saw just couldn’t do so. So if trainee actuaries struggle with it, it’s not surprising that the FOS is worried about the issue. But I doubt it will get resolved quickly, so in the meantime, please, please take the time to work out how much your possessions add up to (this is easiest done on a room by room basis) and make sure you are adequately covered, otherwise risk being much better acquainted with this Principle.

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