Posted on March 4, 2016
Condition of average is the insurance term used when calculating settlement of a claim when the property insured at the time of the loss is of greater value than the Sum Insured.
In the event of a property insurance claim, the amount payable is limited to the sum insured noted on the policy. The Declared Value provided by the Policyholder is the figure used to determine the premium applied to the policy.
If, when taking out a policy, the Policyholder under-estimates the reinstatement value of the property, the property will be under-insured. A condition set by an insurer under the terms of the policy states that if the insurance value of a property at the time of loss or damage is less than its real value, payment by insurers will be reduced according to the difference and insurers will limit their liability by applying what is known as the ‘average clause’.
In effect, this means that the Policyholder is deemed to be the insurer for the amount of any under-insurance at the time of any loss, and even partial losses may be shared in proportion to the amount of under-insurance.
The intention is that everybody pays a premium based on the full value of the subject matter. The formula used to calculate a claim payment subject to the average clause is as follows:
_____________ X LOSS
TRUE VALUE AT RISK
For example, a property with a rebuild value of £500,000 but insured for only £300,000 is 40% underinsured. If the property is damaged, typically by fire, flood, storm and the cost of repairs is £60,000, insurers could reduce the claim by 40%. This means the Insured only receives £36,000 from Insurers, leaving a shortfall of £24,000.
A typical Condition under a standard Commercial Policy Wording is shown below:
Where a Sum Insured is stated to be subject to average, this means that if at the time of Damage, the Sum Insured is less than the total value of the Property Insured, You will
(a) be responsible for the difference
(b) bear a proportionate share of the loss