The ‘Underinsurance’ Trap: Why 2026 Construction Costs Require an Immediate Sum-Insured Review

In 2026, one of the most pressing but often overlooked risks for property owners is not a lack of insurance cover, but the growing gap between insured values and the actual cost of rebuilding.

This gap is being shaped by sustained increases in construction costs, ongoing labour constraints, and continued volatility across the building supply chain. Together, these conditions are steadily reshaping rebuild economics, meaning many assets across Australia are now effectively underinsured without any change to the underlying policy.

For homeowners, SMEs, commercial property owners, and brokers, this shift is increasingly difficult to ignore. Understanding how this gap is forming, and how it can directly influence claim outcomes, has become central to effective risk management in 2026.

Understanding Underinsurance in 2026

Underinsurance occurs when the sum insured on a policy is less than the actual cost required to rebuild, repair, or replace a property at the time of loss.

While the concept is straightforward, the practical implications are often misunderstood.

A sum-insured review in Australia is typically based on estimated rebuild calculators, past valuations, or indexed increases applied at renewal. However, these methods do not always keep pace with real-world construction conditions.

Over time, this creates a disconnect between insured values and true replacement cost, particularly in periods of rapid cost escalation. 

Construction Inflation and the 2026 Cost Environment

A key driver of the current underinsurance issue is ongoing construction inflation in 2026. 

Across Australia, the cost of building has continued to rise due to a combination of factors, including:

• Persistent labour shortages across trades and engineering disciplines

• Increased material costs linked to global supply chain disruption 

• Rapidly increasing fuel prices due to the Middle East war

• Delays and inefficiencies in project scheduling

Recent reporting across the Australian construction sector indicates that building costs are rising again, and at a faster pace than many expected. 

Since the post-pandemic period, construction pricing has remained structurally elevated compared to pre-2020 levels. 

On top of this, the cost of building a new home rose to 3.7% in February 2026, marking the fastest annual increase since October 2024. Industry bodies continue to note sustained pressure from labour shortages, supply chain disruption, and global economic factors, all contributing to ongoing volatility in rebuild costs. 

This creates a growing issue for insurance: policies set three to five years ago may no longer reflect current rebuild realities.

How Underinsurance Develops Over Time

Underinsurance is rarely the result of a single oversight. It typically develops gradually through:

• Outdated valuations carried across multiple policy renewals

• Underestimation of demolition, compliance, and professional costs

• Renovations or improvements not reflected in updated sums insured

• Reliance on generalised calculators rather than site-specific costing

• Inflationary increases that do not match real construction escalation

The result is a silent accumulation of risk, where the insured value increasingly diverges from replacement reality.

The Underinsurance Penalty Mechanism

One of the most important technical aspects of underinsurance is how it is treated at claim stage.

Many policies include an insurance underinsurance penalty clause, often structured as a coinsurance or averaging provision. In simple terms, this mechanism can reduce claim payouts proportionally where the insured amount is below the required replacement value.

For example, if a property is insured for 70% of its actual rebuild cost, some policy structures may only allow recovery of 70% of the assessed loss.

This becomes particularly significant in partial loss events, where policyholders may assume that coverage will respond fully to repair costs. Instead, the claim outcome is adjusted based on the ratio between insured value and actual rebuild cost.

An underinsurance penalty clause can therefore materially reduce settlement outcomes even where a policy is otherwise valid and responsive.

Claims Impact and Financial Exposure

The practical impact of underinsurance becomes most evident during a major loss event.

When a property requires full or substantial reconstruction, insurers assess the cost of reinstatement based on current market rates. If the sum insured is insufficient, several outcomes may occur:

• Reduced settlement proportional to insured value

• Requirement for additional out-of-pocket funding to complete works

• Downsizing or alteration of rebuild scope

• Partial cash settlement instead of full reinstatement

In some cases, policyholders may only realise the extent of the gap once construction pricing and scope assessments are finalised.

This is where underinsurance shifts from a technical policy issue to a direct financial constraint on recovery.

Market Conditions and Rising Dispute Awareness

As construction costs continue to rise, awareness of underinsurance is also increasing across the insurance and advisory sectors.

There is growing reliance on insurance claim advocate support, particularly where policyholders are navigating complex reinstatement scenarios or large-scale property losses.

At the same time, regulatory and dispute resolution bodies such as the Australian Financial Complaints Authority (AFCA) have seen continued engagement in cases where settlement outcomes are impacted by valuation disputes or scope interpretation. 

While not all underinsurance situations result in disputes, the increased complexity of construction costs means more claims now require detailed technical assessment to ensure accurate settlement outcomes.

Risk Management and Sum-Insured Reviews

The most effective way to manage underinsurance risk is through proactive review.

A sum-insured review in Australia should be conducted:

• Annually at renewal

• Following renovations or structural changes

• After significant shifts in construction pricing

• When purchasing or refinancing property

Modern insurer calculators can provide a baseline estimate, but they should be supported by:

• Independent rebuild assessments where appropriate

• Broker review of policy adequacy

• Inclusion of demolition, compliance, and professional fees

• Consideration of local construction market conditions

In high-risk or high-value assets, a more detailed valuation approach is often warranted to avoid systemic underinsurance.

Construction and Commercial Asset Considerations

For commercial property owners, developers, and SME operators, the implications are even more pronounced.

Construction-related assets are exposed not only to inflation risk, but also to:

• Contract variations during build stages

• Delays and escalation clauses in building contracts

• Material availability constraints

• Multi-stakeholder cost variability

These factors make the cost of building in Australia a moving target rather than a fixed valuation.

In this context, insurance should be viewed as a dynamic risk mechanism rather than a static annual product.

Need Help With Your Sum-Insured Review?

If you’re unsure whether your current cover reflects today’s rebuild costs, or you’ve experienced recent changes to your property, it’s worth reviewing your position early.

At Pharos Loss Management, we help policyholders and professionals understand exposure, interpret policy structures, and navigate complex claims environments where valuation, scope, and technical evidence directly influence outcomes.

Reach out for a confidential discussion about your options.

Pharos Loss Management

+61 478 087 092

Declan@pharos.claims

www.pharos.claims