Under-Insurance Is Mis-selling Too: Why Indian Commercial Brokers Need a Documented Risk Basis

Indian mis-selling discourse is dominated by life insurance. ULIPs sold to retirees, endowment plans bundled with home loans, surrender-value misrepresentations. These are real harms and the regulator has spent a decade addressing them through the IRDAI Master Circular on Corporate Agents, 2024, revised suitability disclosures, and persistency-linked clawbacks.

The blind spot sits in commercial lines. A factory owner who buys a fire policy on a Rs 50 crore declared sum insured when the reinstatement value of the plant is Rs 120 crore is, in every operational sense, holding the wrong product. The premium saving is small. The cover gap is structural. When a partial loss occurs, the average clause cuts the claim. The customer thought they had insurance; what they actually had was a fractional claim entitlement.

Brokers tend to push back on the framing. The client signed the proposal. The client declared the values. The client preferred the lower premium. All true. None of it will hold once IRDAI moves to an explicit suitability standard, which the 2026 direction paper has now made visible.

Under-insurance is mis-selling. It is the commercial-lines equivalent of selling a ULIP to a senior citizen. The product does not meet the documented need of the buyer. The broker is the professional in the room. The signature on the proposal is consent, not absolution. This is the conversation the Indian broking industry has not yet had with itself, and the regulator is about to force it.

For a wider view of the commercial mis-selling perimeter, see the hub: commercial mis-selling guide.

Under-insurance in Indian commercial placements is not usually deliberate fraud. It is the cumulative result of weak valuation discipline at several points in the placement chain.

The declared sum insured is set by the client, often from balance-sheet figures: written-down value, depreciated book value, or the historical cost from an asset register that has not been revalued since acquisition. These numbers have an accounting purpose. They do not reflect the cost of replacing the asset on the morning after a fire.

The reinstatement value is what the policy actually responds to under a reinstatement-basis fire cover: the cost of rebuilding the structure and replacing the plant with new equivalent at current prices, including freight, duties, installation, and professional fees. For most Indian manufacturing assets purchased five to ten years ago, reinstatement value is materially higher than book value.

Three common patterns produce a gap:

• Book value vs reinstatement value. A plant capitalised in 2017 at Rs 60 crore now costs Rs 110 crore to rebuild. The asset register still reads Rs 60 crore less depreciation. The declared SI is anchored to the register.
• Stock fluctuation. A trader declares Rs 8 crore of stock at policy inception. During the festive build-up, stock peaks at Rs 14 crore. Loss occurs at peak. SI does not move with stock; declaration policies and floater extensions exist but are often not placed.
• Inflation drift. Steel, civil construction, imported machinery, and labour have all moved upward through 2024 and 2025. A three-year-old SI is structurally short of current reinstatement cost.

A disciplined placement separates accounting value from insurance value, sets the SI on the insurance basis, and documents the rationale. See commercial property valuation methods for the technical detail.

The average clause in the IRDAI Standard Fire and Special Perils Policy converts a quiet under-insurance into a loud claim-cut. The clause is short and unforgiving: if the declared sum insured at the time of loss is less than the actual value of the property insured, the insured is treated as their own insurer for the difference and bears a rateable share of the loss.

Mechanically:

Claim payable = Loss amount × (Declared SI ÷ Actual value at risk)

The two worked examples below are illustrative, not actual cases.

Example 1: factory under-declaration

• Declared SI: Rs 50 crore
• Reinstatement value of plant and building at time of loss: Rs 120 crore
• Partial fire loss: Rs 30 crore
• Claim payable: Rs 30 crore × (50 ÷ 120) = Rs 12.5 crore
• Customer shortfall absorbed: Rs 17.5 crore

The client expected a Rs 30 crore recovery and received Rs 12.5 crore. The premium saving over the prior years was a fraction of a percent of the shortfall.

Example 2: peak-season stock

• Declared SI for stock floater: Rs 8 crore
• Actual stock at risk on loss date (festive build-up): Rs 14 crore
• Loss to stock from sprinkler failure and water damage: Rs 6 crore
• Claim payable: Rs 6 crore × (8 ÷ 14) = Rs 3.43 crore
• Customer shortfall: Rs 2.57 crore

The declaration policy mechanism, which adjusts premium against monthly stock declarations, exists precisely to neutralise this risk. It is widely available and frequently not placed because the buyer was not walked through the alternative.

In both cases the policy responded. The contract was honoured. The customer is still short. The post-mortem question every Indian broker should rehearse: when the client asks why the broker did not flag the gap, what does the file say?

The Indian broker's legal exposure on under-insurance sits across three regulatory and statutory layers.

First, the IRDAI (Insurance Brokers) Regulations, 2018 impose a Code of Conduct that requires brokers to act with due care, skill, and diligence; to render advice on the basis of an objective and independent analysis; and to ensure that the policy recommended is appropriate for the client's needs. A broker who places a fire policy on book-value SI without raising the reinstatement gap has not met the due-care standard.

Second, the IRDAI (Protection of Policyholders' Interests) Regulations, 2017 apply through the distribution chain. The regulations require clear disclosure of material features and risks. Under-insurance is a material risk. The average clause is a material feature. A placement file that contains no record of either being discussed with the client is exposed.

Third, the Consumer Protection Act, 2019 treats professional advice as a service. Deficiency in service by a service provider is actionable. The District and State Consumer Commissions have already heard cases where insurance intermediaries have been found liable for inadequate advice. The Act's enhancement of consumer remedies, including the National Consumer Disputes Redressal Commission's pecuniary jurisdiction at the higher band, makes the broker a meaningful target.

The directional shift is more important than the current state. The IRDAI's signalling through 2025 and 2026 has moved toward an explicit suitability obligation modelled on US Department of Labor and UK Financial Conduct Authority standards. Under such a regime, the burden of proof inverts. Today the client must show that the broker mis-sold. Tomorrow the broker must show that the placement was suitable. "The client decided" survives in the first world. It does not survive in the second.

Broker E&O policies follow the regulatory perimeter. Underwriters will increasingly ask for evidence of a suitability process before binding renewals. Placements with no documented SI rationale will price up or carry exclusions.

A defensible placement file does not require a forensic valuation on every account. It requires a documented chain of reasoning, proportional to the size and complexity of the risk.

At quotation, the file should record the basis on which the sum insured was framed. Is it book value, market value, agreed value, or reinstatement value? If the client has provided a number, the file should record where that number came from: chartered engineer's certificate, internal asset register, insurer's valuation, or client estimate.

At placement, the file should show that the average clause was explained in writing, that the difference between book value and reinstatement value was raised, and that the client's instruction to proceed at the declared SI was recorded. If the client declines a higher SI, the decline should be in writing, with the broker's recommendation also in writing.

At renewal, the file should show that the SI was revisited against current values, current asset additions, and current stock patterns. A renewal that simply re-runs last year's SI with a marginal inflation tick is the highest-risk pattern in Indian commercial broking.

This is where infrastructure matters. Sarvada Risk Intelligence produces a company risk profile that includes indicative sum insured ranges, grounded in industry data, plant configuration, workforce, and occupancy. The policy gap analysis flags the declared SI against estimated reinstatement value and surfaces under-insurance with the IRDAI citations attached. The output is a record showing the broker raised the gap with the client, with a defensible basis. This is documented diligence, not compliance theatre.

For placements above a threshold the broker should set internally, a chartered engineer's reinstatement valuation should sit on the file. Below that threshold, a defensible indicative basis with disclosed limitations is the minimum bar.

The shortest test: if the file went to the IRDAI tomorrow as part of a market-conduct review, would the broker rather defend the SI rationale or settle the complaint?

The IRDAI's 2024 consultation paper on standards for insurance distribution, followed by the corporate-agent master circular and the broker-channel signalling through 2025 and 2026, points in one direction: documented suitability is becoming the baseline, not the upper bound.

The Indian regulator's reference points are visible. The US suitability and best-interest framework for retirement and insurance products. The UK Financial Conduct Authority's consumer-duty regime, which requires firms to act to deliver good outcomes for retail clients across the product life cycle. Both move the analytical centre from disclosure to outcome: it is no longer sufficient to disclose, the seller must justify that the product was right.

What this means in practice for an Indian commercial broker over the next 18 to 24 months:

• SI rationale becomes a routine file artefact, not a special exercise on large risks.
• Average-clause explanation becomes a standard placement document, signed off by the client.
• Declaration policies, floaters, and reinstatement-value endorsements become products that have to be offered and the decline documented.
• Renewal questions about asset additions, value drift, and stock pattern changes become contractual touchpoints rather than informal chats.
• E&O underwriting will start asking for evidence of these processes at the broker level.

The brokers who move first will find the cost of compliance low and the competitive advantage real. Sophisticated commercial buyers, particularly mid-market manufacturers and warehousing operators, are already asking these questions of their incumbent brokers. Those who cannot answer are losing accounts to those who can.

Under-insurance has been the quiet failure of Indian commercial broking for two decades. The 2026 direction is to make it loud. The broker's response should be a documented risk basis from quote to claim, not a louder defence of the proposal signature.