‘Average clause’ in insurance is applicable for which one of the following cases?
Under insurance
Understanding the Average Clause in Insurance
The question asks about the 'Average clause' in insurance and when it is applicable. This clause is a key concept in property insurance and affects how claims are settled under specific circumstances.
What is the Average Clause?
The Average Clause, also known as the co-insurance clause in some regions, is a provision in an insurance policy that comes into play when the insured property is under insured. Its purpose is to ensure that the insured party shares the risk of loss if they choose to insure their property for less than its full value.
What is Under Insurance?
Under insurance occurs when the sum insured (the maximum amount the insurance company will pay out) is less than the actual market value or replacement cost of the insured property at the time of the loss.
For example, if a building is worth $1,000,000, but the owner insures it for only $500,000, it is under insured.
Why the Average Clause Applies to Under Insurance
When a loss occurs to an under insured property, the insurance company applies the Average Clause to calculate the claim payment. Instead of paying the full amount of the loss (up to the sum insured), the insurer pays only a proportion of the loss.
The principle is that if you insure only a part of the value, you are considered to be your own insurer for the remaining part. Therefore, you share in any loss in proportion to the uninsured value.
The formula for calculating the claim amount under the Average Clause is typically:
Claim Amount = (Sum Insured / Actual Value of Property) × Amount of Loss
Let's look at an example:
| Detail | Value |
|---|---|
| Actual Value of Property | $1,000,000 |
| Sum Insured | $500,000 |
| Amount of Loss (due to fire, for example) | $200,000 |
Using the Average Clause formula:
Claim Amount = ($500,000 / $1,000,000) × $200,000
Claim Amount = (0.5) × $200,000
Claim Amount = $100,000
In this example, despite having a $200,000 loss and a sum insured of $500,000, the insured only receives $100,000 because the property was under insured, and the Average Clause was applied.
Analyzing Other Options
- Double Insurance: This occurs when the same property is insured with two or more different insurance companies. The Average Clause is not directly applicable here; instead, contributions from each insurer might be sought.
- Re-insurance: This is insurance purchased by an insurance company from another insurance company to transfer risk. It is an arrangement between insurers and does not involve the Average Clause in the context of a policyholder's claim.
- Over insurance: This occurs when the sum insured is more than the actual value of the property. Insurance contracts are indemnity contracts (except for life insurance), meaning the insured should not profit from a loss. In case of a claim under over insurance, the insurer will typically pay only the actual value of the loss or the actual value of the property, whichever is lower, regardless of the sum insured. The Average Clause is not applied.
Based on the definition and application, the Average clause in insurance is applicable for cases of under insurance.
Revision Table: Insurance Clauses
| Term | Description | Average Clause Application |
|---|---|---|
| Under Insurance | Sum insured is less than actual value. | Applicable - Claim paid proportionally. |
| Over insurance | Sum insured is more than actual value. | Not Applicable - Claim limited to actual loss/value. |
| Double Insurance | Same property insured with multiple insurers. | Not Applicable - Contribution principle applies. |
| Re-insurance | Insurance for insurers. | Not Applicable - Business between insurers. |
Additional Information: Importance of Adequate Insurance Coverage
Understanding the Average Clause highlights the importance of insuring property for its correct value. If a property is significantly under insured, a partial loss can result in a much smaller claim payment than expected, potentially causing significant financial hardship for the insured party.
Insurance companies often recommend regular reviews of the sum insured to ensure it reflects the current replacement cost or market value of the property, taking into account factors like inflation, renovations, and market changes. Avoiding under insurance is crucial to receive full compensation for losses up to the sum insured.
Important Questions from Insurance
Given below are two statements
Statement I: In the case of Life Insurance, the insurable interest must be present in the person insured at the time when the event happened.
Statement II: In the case of Fire Insurance, the insurable interest must be present in the object insured at the time when the policy is taken and the event has happened.
In light of the above statements, choose the correct answer from the options given below
Which of the following sentences explains the principle of utmost good faith in insurance?
Who among the following relatives of a deceased insured person is not “dependent” under the Employees’ State Insurance Act, 1948?
When did Life Insurance Corporation come into existence ?
In the format of an account in the ledger, the columns usually do NOT contain the __________.
