Since we agree no one can afford not to have an insurance, it is better to underinsure than not insuring at all. Some of us may think that it is actually ok to underinsure. But is it really ok? Do we understand the risks?

We must first understand the meaning of underinsuring. When we underinsure, it simply means that the insured sum is significantly less than the actual value of the insurable interest.

For example, if we take up a fire insurance for our house for RM1 million while its re-construction cost is RM1.5 million, thinking that as long as our house is not completely burnt down, the insured amount of RM1 million should be enough to cover the repair in most cases. Wrong!

Another example, a condominium block is insured for RM50 million while its current re-construction cost is RM80 million. The Condominium Management may think that the RM50 million insured sum is more than enough to cover the repair as it is unlikely all units are destroyed in a fire. Wrong again!

When assessing your claim, invoking what is known as the average clause provision in the policy, the insurance company will compute the actual value that you should be insuring and determine your share of the risk based on a proportionate risk sharing approach.

If you insure your house for RM1 million and its actual value is RM1.5 million, you are deemed to have accepted 33% of the risk while the insurance company bears 67% of it. That means if the repair cost is RM800,000, the insurance company will only pay 67% of RM800,000, i.e. RM536,000!

In the case of the condominium above, if the repair cost due to fire is RM5 million, the insurance company will only pay 63% of RM5 million, i.e. RM3.15 million.

Therefore, when you buy a general or motor insurance, you should understand how the average clause provision affects you in your claim for compensation.

So, do you still think that underinsuring is ok?