Average clause and under-insurance

What is the average clause?

The average clause, also called the condition of average, is a term in property policies that makes the policyholder share a loss when the property is under-insured. If the sum insured is less than the true value of the property at the time of loss, the insurer pays only the proportion of the loss that the sum insured bears to that value. The policyholder is treated as their own insurer for the uninsured share.

Under-insurance is the situation the clause addresses: the insured has declared, and paid premium on, a lower value than the property is worth. The clause keeps premiums fair across customers, since someone who insures at half value should not receive full payment on partial losses while paying half the premium.

How the average clause works

The formula is:

Claim payable = Loss × (Sum insured ÷ Value at risk at the time of loss), then less any excess, and never more than the sum insured.

Worked example: a warehouse building has a reinstatement value of ₹4 crore but is insured for ₹3 crore. A fire causes damage of ₹80 lakh.

The value is measured at the date of loss, not at policy inception. Inflation in construction costs, new machinery bought during the year, or a seasonal build-up of stock can create under-insurance even when the original value was correct. The surveyor checks values as part of the loss assessment.

Where the average clause applies in India

Some commercial policies soften the effect with tools such as declaration policies for fluctuating stock, floater covers across locations, escalation clauses that raise the sum insured automatically during the year, and agreed value cover for items like art.

Why under-insurance happens

• Insuring the purchase price or book value instead of the current replacement cost.
• Leaving contents at a token figure while insuring the building carefully.
• Not updating values after expansion, new machinery or price rises.
• Cutting the sum insured to lower premium.
• Stock peaks during festive or harvest seasons that the policy does not track.

What the average clause means for distribution

• It is the most common source of property claim disputes. Customers see a partial payment as the insurer "cutting" the claim. Most of these disputes trace back to a valuation set at the point of sale. Explaining average before the sale is the best complaint prevention available.
• Valuation is part of advice. A good intermediary helps the client arrive at a reinstatement value, using construction cost per square foot, machinery replacement quotes and peak stock figures, and records how the value was set.
• Renewal is when to fix it. A one-line question at renewal ("has anything been added or have costs risen?") with a suggested indexation prevents slow drift into under-insurance.
• Standard products are a selling point. The no-average feature of Bharat Griha Raksha and the 15 per cent waiver in the MSME products answer a common objection directly, and suit retail and SME channels.
• Under-insurance is a conduct issue. Selling a low sum insured to win on price, without explaining the consequence, can be seen as mis-selling when the claim arrives.