Under Insurance in Motor Claims - With Example

In motor insurance, under-insurance occurs when the sum insured (often referred to as the Insured Declared Value or IDV) is less than the actual market value or replacement cost of the vehicle at the time of loss. 

The IDV is the maximum amount an insurer will pay in case of a total loss or theft of the vehicle. In motor insurance, under-insurance typically affects claims for Total Loss (where the vehicle is fully destroyed or stolen) or Constructive Total Loss (where repair costs exceed a certain percentage of the IDV, usually 50%).

If the IDV is set lower than the vehicle’s actual value, the claim payout will be insufficient to replace the vehicle or cover the full loss that lead to Under-Insurance.

Example: 

A car owner insures their vehicle, valued at $20,000 in the market, with an IDV of $15,000 to reduce the premium. The car is stolen, resulting in a total loss.

Calculation:

The insurer will pay the IDV, which is $15,000.

The actual market value of the car is $20,000.

Outcome: The policyholder receives $15,000, which is $5,000 less than the car’s actual value, leaving them unable to purchase a similar vehicle without additional funds.

Causes of Under-Insurance in Motor Insurance:

• Choosing a lower IDV to reduce the premium cost.
• Lack of awareness about the importance of setting an accurate IDV.
• Failure to update the IDV when renewing the policy, especially as the vehicle’s value depreciates.
• Misrepresentation of the vehicle’s condition or value at the time of policy purchase.

Prevention:

• Ensure the IDV is set based on the current market value of the vehicle, considering its make, model, age, and condition.
• Avoid deliberately lowering the IDV to save on premiums.
• Review the IDV at each policy renewal to reflect the vehicle’s current value.
• Use online tools or consult with the insurer to determine a realistic IDV.