A fire insurance policy has an average clause mentioned in it which takes care of the cases of under-insurance. If insured the assets in the fire insurance policy, for less than their full value, the insured requires to bear a proportion of the loss according to the average clause mentioned in the policy document.
Since the fire insurance policy is a contract of indemnity, the insured cannot claim more than the actual amount of loss caused by the fire.
According to the average clause in the fire insurance policy
- If the actual cost of the goods/property is higher than the sum insured for such goods/property, then the insured has to bear the difference.
- The insured must bear the cost arising due to the difference between the actual value of goods/property and the amount insured for it.
- The insurers or the insurance company will only pay for the rateable proportion of the loss.
- The average clause applies only when the sum insured is less than the actual value of the goods or the property.
Due to the presence of the average clause in the fire insurance policy, the liability of the insurance company would reduce as per the application of the proportionate approach. The insurers do not pay the full amount of loss incurred to the insured. The insured is then responsible for the payment of the unpaid claim amount.
Average Clause Short Note
The average clause in a fire insurance policy ensures that if an asset is underinsured, the insured must bear a proportionate amount of any loss. This clause prevents the insured from claiming more than their fair share relative to the coverage they have paid for, ensuring equitable distribution of insurance payouts and promoting adequate insurance coverage.
Read more: What is the Scope of Fire Insurance Policy?
Calculation of claim amount under Fire Insurance
Thus, the calculated amount of claim that the insured gets would be as:
Claim amount= (Actual loss × Insured amount) /Value of goods or property at the date of the fire
Suppose a property worth Rs. 15,00,000 is insured for Rs. 13,00,000 and the fire insurance policy has the average clause in it. If half the property is damaged due to the fire, the loss that the policyholder incurs is about 7,50,000 based on the current worth of the property (half the amount). However, the amount paid by the insurer is:
= (7,50,000 × 13,00,000)/ 15,00,000
=6,50,000
So, the additional amount of Rs. 1,00,000 (7,50,000 – 6,50,000) has to be borne by the insured himself.
How the Average Clause in Fire Insurance Affects Your Business Insurance Coverage
Case Study: Claim settlement under Fire Insurance
Hemant, a 42-year-old individual was the owner of a factory, manufacturing woolen clothes. His factory was located in Amritsar and catered to client requirements all over Punjab. He exported the finished products as well as the raw materials as per the needs of the clients.
In May 2006, a fire broke out in his factory and damaged half of the stock which was to be shipped to a nearby cloth dealer. The workers could recover the other half of the stock safely before the fire engulfed it.
Hemant had a fire insurance policy cover taken to protect his stock. As the fire gutted half of the stock, Hemant contacted his insurance company to cover the losses incurred.
Read more: What are the physical hazards in fire insurance?
His fire insurance policy had the average clause in it. Upon investigation, the surveyor found that the fire was caused due to a short circuit in the production area; hence, half of the stock was burnt and damaged.
Following are the details of the stock:
- Actual value of the stock: Rs 3,00,000
- Sum insured for the stock: Rs. 2,00,000
- Loss incurred: Rs. 1,50,000 (As half the stock was destroyed)
Hence, the insurance company settled the following claim amount for Hemant as per the average clause mentioned in his fire insurance policy:
Claim amount= (Actual loss × Sum insured) /Value of stock at the date of the fire
= (1,50,000 × 2,00,000) / 3,00,000
=1,00,000
Thus, Hemant’s insurers paid the claim amount of 1 lakh, although the actual loss amount was rupees 1.5 lakhs. Hemant had to himself bear the additional loss of fifty thousand rupees from his own pocket.
FAQ
- What is the average clause in fire insurance?
The average clause in fire insurance is a provision that ensures the policyholder is adequately covered for the full value of their property. It stipulates that if the insured amount is less than the actual value of the property at the time of loss, the insurance company will only pay a proportionate amount of the claim.
- How does the average clause affect my insurance coverage?
The average clause serves as a safeguard to encourage policyholders to insure their property for its true value. If the insured amount is found to be less than the actual value of the property, the insurance payout will be reduced accordingly.
- How can I avoid the implications of the average clause in fire insurance?
To avoid being subject to the average clause, it is crucial to accurately assess and insure your property for its current market value. Regularly reviewing and updating your insurance coverage can help prevent any underinsurance issues.
- What happens if my property is underinsured and a fire occurs?
The insurance company will apply the average clause if your property is underinsured and a fire occurs. This means that the payout for the claim will be adjusted based on the insured amount’s ratio to the property’s actual value.
- Can the average clause impact the settlement of my fire insurance claim?
Yes, the average clause can impact the settlement of your fire insurance claim if your property is underinsured. It may result in a reduced payout from the insurance company, leaving you responsible for covering the shortfall.
About The Author
Shivani
MBA Insurance and Risk
She has a passion for property insurance and a wealth of experience in the field, Shivani has been a valuable contributor to SecureNow for the past six years. As a seasoned writer, they specialize in crafting insightful articles and engaging blogs that educate and inform readers about the intricacies of property insurance. She brings a unique blend of expertise and practical knowledge to their writing, drawing from her extensive background in the insurance industry. Having worked in various capacities within the sector, she deeply understands the challenges and opportunities facing property owners and insurers alike.
