Underinsurance and the Average Clause – Avoiding Reduced Payouts

Underinsurance remains a significant risk for UK landlords, as it can lead to substantial reductions in insurance claim payouts due to the application of the average clause. Understanding how to correctly calculate the sum insured, particularly the rebuild cost rather than market value, is essential to ensure full claim settlements and avoid unexpected financial losses.

Understanding Underinsurance and the Average Clause

Underinsurance occurs when the insured sum is less than the actual value required to cover a property adequately, typically the rebuild cost rather than the market value. For landlords, this often means undervaluing the cost to rebuild the property, including necessary professional fees and debris removal.

The average clause is a common feature in landlord insurance policies that penalises underinsurance by reducing claim payouts proportionally. For example, if a property is insured for only 75% of its true rebuild cost, any claim may be reduced by 25%. This reduction applies to all parts of the claim, including building repairs, contents, and sometimes loss of rent, potentially turning manageable incidents into significant financial burdens.

Rebuild Cost Versus Market Value

It is crucial to distinguish between market value and rebuild cost. Market value includes land price, location, and demand, which insurers do not consider when assessing risk. Instead, insurers require the cost to rebuild the property to current standards, factoring in materials, labour, professional fees, debris removal, and any necessary code-compliance upgrades such as fire doors or emergency lighting in HMOs.

In some areas, such as London, market value may far exceed rebuild costs, while in others, rebuild costs may be closer to market values. Landlords should always insure based on rebuild costs to ensure adequate coverage.

Components to Include in the Buildings Sum Insured

• The full rebuild cost of the dwelling to an equivalent specification.
• Professional fees, including architects, engineers, surveyors, and planning fees.
• Debris removal and site clearance expenses.
• Outbuildings, boundary walls, gates, fences, drives, and paths if required by the policy.
• HMO-specific upgrades such as fire doors, alarm systems, and emergency lighting where applicable.
• VAT costs if the landlord is not VAT-registered and would incur VAT on rebuild works.

Policies vary in how they include professional fees and debris removal—some incorporate these within the buildings sum insured, while others provide separate limits. Landlords must ensure the overall allowance is sufficient regardless of the policy structure.

Landlord Contents and Loss of Rent Cover

For furnished lets, landlords should set a realistic sum insured for contents, covering furniture, appliances, curtains, blinds, and floor coverings they own. A nominal contents limit, such as £5,000, may be inadequate if quality furnishings are installed. It is important to note that tenants’ possessions are not covered under the landlord’s policy.

Loss of rent cover is typically limited by time (commonly 12, 18, or 24 months) and sometimes by a monetary cap. Complex reinstatement projects, such as those involving fire damage, subsidence, or listed buildings, can exceed 12 months, so landlords should consider longer periods of 18 to 24 months. Additionally, some policies link loss of rent cover to the buildings sum insured, meaning underinsurance of the building can also reduce income protection.

Protecting Against Underinsurance: Day One Reinstatement and Declaration-Linked Cover

Two policy features can help mitigate underinsurance risks:

• Day One Reinstatement policies require landlords to declare the current rebuild value (the declared value). The insurer then applies an automatic uplift, often between 15% and 50%, to account for inflation between the policy start date and any future claim. Accurate initial valuation remains essential.
• Declaration-linked (adjustable) policies are common for portfolios, requiring annual declarations of property values. Insurers apply uplifts or adjustments at year-end, but again, the starting figures must be accurate.

While index linking helps adjust sums insured mid-term, it cannot correct an initially inaccurate declared value.

Common Causes of Underinsurance Among Landlords

• Using the purchase price or mortgage valuation instead of the rebuild cost.
• Omitting professional fees and debris removal costs.
• Failing to update sums insured after extensions, loft conversions, or HMO upgrades.
• Excluding outbuildings, boundary walls, and hard landscaping when required.
• Setting a 12-month loss of rent limit for properties that realistically require longer reinstatement periods.
• Assuming the freeholder’s block insurance covers landlord contents and loss of rent exposures within the leasehold area.

Leasehold Properties and Block Insurance Considerations

For flats, the freeholder or residents’ management company (RMC) often insures the building. However, landlords still need to insure landlord contents, loss of rent (if permitted by the lease), and liability. It is advisable to obtain and review a copy of the block policy to verify sums insured, covered perils (including escape of water), and excesses. Underinsurance at the block level can expose landlords to indirect risks through claim delays or shortfalls.

Waiver of Average: A Limited but Useful Option

Some specialist insurers offer a waiver of average or limited tolerance, for example, waiving average if the sum insured is within 10–15% of the correct value. These options are not widespread and often come with conditions such as requiring a professional valuation or Day One wording. While helpful, they should not be viewed as an excuse to underinsure.

Example Calculation: Setting the Correct Sum Insured

Consider a two-storey semi-detached property with an extended kitchen and HMO upgrades such as fire doors and alarms:

• Base rebuild estimate: £240,000
• Professional fees (10%): £24,000
• Debris removal/site clearance (7%): £16,800
• Outbuildings, boundaries, hardstanding: £9,200
• Total declared value: £290,000
• Day One uplift (25%): policy limit effectively around £362,500

If the property had been insured at £220,000 to reduce premiums, this would represent approximately 24% underinsurance at inception, triggering the average clause and reducing any claim by a similar proportion.

Checklist to Avoid Underinsurance

• Obtain a professional rebuild assessment or use a recognised calculator, ensuring unusual features are considered.
• Include professional fees and debris removal according to your policy’s structure.
• Include VAT if you are not VAT-registered.
• Review sums insured after any works such as extensions, loft conversions, or compliance upgrades.
• Use Day One reinstatement with an appropriate uplift, often 25–35% for portfolios.
• Set loss of rent cover to match actual rent and consider longer durations (18–24 months) for complex risks.
• Maintain a detailed property schedule listing declared values, contents limits, loss of rent periods, excesses, and special features.
• Ask your insurer about waiver of average options and understand any conditions attached.

Conclusion

The average clause is a significant factor that can reduce insurance claim payouts by thousands of pounds if sums insured are inaccurate. Landlords should prioritise setting correct sums insured, utilise Day One reinstatement where appropriate, and regularly review values after property works. These measures form an essential part of risk management alongside routine inspections and compliance checks, ensuring that insurance policies provide full protection when claims arise.

Additional Information for Landlords

The Landlord Association (TLA) is launching a new Trusted Partners Hub in the first quarter of 2026. This platform will feature verified and approved service providers selected to support landlords, tenants, and property management businesses. Legal, trades, insurance, financial, mortgage, tenant screening, and other service providers are invited to register their interest here: https://landlordassociation.org.uk/become-a-tla-service-partner/.