The Great British Haircut

Four times now this series has watched Derek pay too much: for a discount that wasn’t, to a comparison engine that hid half the market, for the sin of paying monthly, and for a written-off car settled with a cheque thinner than the car was worth. This morning, a pipe bursts in his kitchen. The flood is small; the damage is £6,200. The cheque, when it arrives, will be for £3,425. He is about to discover the clause Parliament thought it had killed in 2012.

An insurance policy is, in the cold accounting, a single number: the number that lands on the doormat when something has gone wrong. The premium is the price of waiting for that number. The schedule is the set of rules for finding it. The brochure is the prose around it. Derek has been waiting for nineteen years. The pipe burst at six on a Sunday morning. The number, when it arrives, will be wrong by forty-five per cent, and the reason will be a clause he never read, applying a multiplier he never understood, to a figure the insurer was at least as well-placed to know as he was.

That an insurer pays too little is no thesis to detain a serious person. The story is two facts stranger than that. First, the figure the industry shaves from Derek’s cheque is one Parliament took the trouble to outlaw, in clear and considered legislation, fourteen years ago; and the industry rebuilt it, in identical operation, inside the small print of every policy schedule. Second, the regulator that holds the law has elected not to enforce it. The Financial Ombudsman is doing the work instead, in private, one complaint at a time, in a persistent campaign about which insurer-side lawyers are openly complaining in the trade press. The practice continues at scale because the customers who complain are a vanishingly small fraction of the customers who simply pay.

This is, in short, one of the cleanest pieces of regulatory archaeology in British consumer finance. A statute. An industry workaround. An ombudsman patching the gap, case by case, behind closed doors. A regulator looking the other way.

The Multiplier on Every Cheque

The cause of Derek’s missing two thousand seven hundred and seventy-five pounds is the average clause: the contractual term that operates not as a ceiling on his cover but as a coefficient on every claim. The arithmetic is brutal in its simplicity. The cost of rebuilding his house, at current trade prices, is around three hundred and eighty thousand pounds. The figure on his policy schedule is two hundred and ten thousand. He is, in the industry’s term of art, insured for fifty-five per cent of his risk. So the insurer pays him fifty-five per cent of his claim. Of any claim. Of every claim, regardless of how comfortably each one fits within the sum insured. The £6,200 flood becomes a £3,425 cheque. The £900 boiler call-out becomes a £497 cheque. The £14,000 roof becomes a £7,737 cheque. The same coefficient, applied without mercy, on every cheque until Derek either revises the figure or dies, whichever comes first.

Note what the coefficient does not depend upon. It does not depend on whether Derek’s claim approaches the sum insured. It does not depend on whether his loss was a kind the insurer charged him for. It does not depend on whether the insurer ever asked him for an accurate figure. It depends on one thing only: the gap between a number Derek typed into a webform six renewals ago and a number nobody on either side of the policy has measured since. The gap, in his case, is fifteen years of construction inflation, including the extraordinary year of 2022, in which the cost of building a British house rose by nineteen per cent in twelve months. Whole policy schedules went out of date inside one summer.

Derek is not unusual. The most-cited industry survey, drawn from over forty thousand recent property assessments, finds that only seven of every hundred UK homes are insured for the cost of rebuilding them. The other ninety-three are exposed to precisely Derek’s coefficient, in many cases without ever having heard of it.

The Statute the Industry Outran

Here the story turns from arithmetic to law, and from misfortune to design.

In 2012, Parliament passed the Consumer Insurance (Disclosure and Representations) Act. The Act was the product of seven years of Law Commission work and a settled view, agreed across the industry and the consumer bodies, that consumers should not be ruinously punished for getting a figure on an insurance form slightly wrong. The Act introduced a proportionate remedy: where a consumer carelessly understates a material fact, the insurer’s payout is reduced, but in proportion to the premium the insurer would have charged, not the sum insured the consumer guessed wrong. If the truthful answer would have caused a ten-per-cent-higher premium, the insurer pays ninety-one per cent of the claim. If the truthful answer would have produced the same premium anyway, the insurer pays the lot. Parliament’s logic was specific and intentional: the consumer’s penalty should match the money the insurer was actually out of pocket for, not the figure the consumer guessed wrong about.

In 2015, the Insurance Act extended the same regime to commercial policies, leaning on the same Law Commission analysis. The proportionate-remedy approach was, by then, the settled law of British insurance disclosure. It applies, of course, only when there is something for it to apply to. If the contract has already decided the cheque, CIDRA arrives too late.

The average clause is the contractual term that decides the cheque, and the manoeuvre by which it does so is the whole trick. CIDRA polices remedies for consumer mistakes. It was drafted on the assumption that when an insurer wants to dock a claim because a customer got a number wrong, that docking is a penalty, and the law gets to constrain how severe the penalty can be. So the industry, for the better part of a century, has insisted that the average clause is not a penalty at all. It is, on its own telling, the definition of cover itself: a built-in formula for what the insurer ever promised to pay in the first place. The insurer is not punishing Derek for understating his rebuild cost. It is, it says, paying him precisely what the policy always said it would pay him, which happens to be his declared sum divided by his true rebuild cost, multiplied by the loss. Framed that way, there is no misrepresentation to remedy, because Derek has done nothing wrong: there is only the calmly worded arithmetic of a payment formula he agreed to when he bought the policy. CIDRA, designed to constrain harsh remedies, looks at the page, finds no remedy in it, and walks past. The harsh outcome Parliament passed CIDRA to abolish is preserved, intact, as the contractual definition of cover.

In mass-market home insurance, the two regimes produce starkly different cheques. The statutory remedy, premium-based, pays Derek almost the whole of his £6,200, because his sum insured of £210,000 against its correct figure of £380,000 would have produced a barely-different premium under standard mass-market pricing. The contractual remedy, sum-insured-based, pays him £3,425. The difference between the two cheques is the difference between the law as written and the law as practised — the industry, which had campaigned against the statutory regime at every stage, accepted defeat in the legislation and reopened the same battle in the schedule.

In neither case is the position one Parliament intended. In neither case has the regulator that holds the law lifted a finger about it.

The Ombudsman’s Case-by-case War

The work the regulator declines to do has fallen, by default, on the Financial Ombudsman Service. In July 2023 the FOS issued guidance on home underinsurance complaints which contained, in the suppressed language of British civil servants, the most violent regulatory sentence of the decade: “we rarely agree for an insurer to apply average”. The ombudsman, in other words, will not enforce the contractual clause. He performs the inverse of the industry’s move: where the insurer insists that the average clause is merely the agreed definition of cover, the ombudsman calls the underinsurance what it always was in substance, a customer’s honest mistake about rebuild cost, and applies the statutory remedy CIDRA already provides for exactly that situation. The premium-based reduction, not the sum-insured-based one. The lighter cheque becomes the heavier one.

The trade press has noted the strategy is being conducted “almost by stealth” and that insurers are “quite irritated” at being made to pay. The partner at Kennedys who supplied that quote is an insurer-side lawyer, the irritation he is describing is his own clients’, and the underlying complaint is that the FOS is forcing them to honour the law rather than the policy. The cleaner reading: a regulated industry resents being held to a statute its lobbyists could not amend.

The mechanism, for the customer, is the price-walking pattern we have met before in this series, in another costume. The customer who escalates a complaint receives the statutory cheque. The customer who does not, keeps the contractual one. About thirty-eight per cent of buildings insurance complaints to the FOS are upheld; for the worst-performing firm, the rate on claim-value disputes runs at sixty-one per cent. Better than half a coin-toss in your favour, but only if you toss the coin. The other ninety-something per cent of underinsured Dereks never reach the table.

A Free Option, Again

The reader who has followed this series will recognise the shape of the thing now without being told. A practice the regulator could outlaw and won’t. An ombudsman correcting the worst cases one at a time, in private. The remaining customers banking the haircut and saying nothing. We have seen this pattern at the door of entry, in the middle of the term, and at the point of claim. We are now seeing it for the home.

Run an option trader’s eye over it again. The insurer’s loss-cost models, calibrated for years to a market in which roughly seventy per cent of homes are underinsured, price the premium on the (too-low) sums insured those very customers declared. The average clause is then applied at claim time, producing a haircut on every cheque the insurer writes. When a customer complains and reaches the FOS, the haircut is reversed, and the insurer hands over the difference. The annual volume of buildings complaints reaching the FOS runs to roughly six and a half thousand. The number of UK home insurance policies in force is of order twenty million. The leakage from the option is three-hundredths of one per cent. The option remains, to a vanishingly small set of decimal places, free.

The list of statutes the industry has outrun this decade are not short. This one is merely the most politely worded.

Where the Honest Products Went

It is, at this point in the series, almost a refrain. Some insurers do this properly. A handful offer policies whose buildings cover is sold as “unlimited”, with the insurer dispensing with a sum-insured figure altogether. Others sell bedroom-rated policies, pricing on the number of rooms in the property and sparing the customer the rebuild figure entirely. Beneath the household names there is a hinterland of mid-net-worth and surveyor-assessed products that ask the proper question of rebuild cost and pay properly when the answer is honest. The honest insurer is, in the home market, not invisible. It is merely marked up.

One detail is worth flagging, because the word that sells the honest market is doing the most work in it. “Unlimited” in the insurance trade is a word with footnotes. The wording typically offers unlimited cover “for most customers”, a curious construction, the swimming pool that is bottomless for most swimmers. Inner limits on trace-and-access, on alternative accommodation, on outbuildings, on contents replacement do meaningful and unadvertised work in the small print of products whose marketing promises none.

None of which much matters, because none of these products is what Derek’s eye, trained by three renewals on the comparison panel, will rest on. The insurer that carries a proper rebuild cost on its book must charge a higher premium for it. A higher premium is a lower rank. A lower rank is below the fold. Derek scrolls to the cheapest line, picks it, and pays his £312 a year. He does not, in any meaningful sense, choose the policy that will fail him. He selects, for the fourth year running, against himself.

The Willing Victim

Derek banks the cheque. Drying out the kitchen on a hired industrial fan, the cheque arrived three weeks later in the same envelope as the renewal invitation. The cabinets, narrower by two thousand seven hundred and seventy-five pounds than the cabinets they replaced, are installed without complaint. The meerkat, plush and button-eyed, watches the post from the mantelpiece of a house insured for fifty-five per cent of itself.

He will not write the letter. He will not call the FOS. He has not heard of CIDRA, the statute that would have paid him in full. He supposed he had less reasons to argue than in fact he had. What passed between he and the loss adjuster was a short, polite conversation about a clause he did not know existed, conducted by a man paid by the insurer to apply it. Derek did not write back, he banked the cheque.

The same coefficient will apply to the boiler in 2027, to the rewiring in 2029, to the roof in 2032. He is, for the remainder of his ownership of the house, paying a full premium for a policy he reads as comprehensive and the insurer reads as a fraction. The gap between the two readings is the industry’s stealthy annuity.

This series has, on the way through, been accused of being hard on Derek. It was never hard on Derek. The hardness in these pages was only ever for an industry that priced him correctly going in, paid him fractionally coming out, named the difference an average — the gentlest word in the English language for the unmarked, unmissable, multiplicative tax he never knew he was paying.

The meerkat says nothing. It never has. It is, this year, the only thing in the house insured for what it cost.