Property Insurance

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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.

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

The average policy in fire insurance can impact the coverage and settlement amount in case of a loss or damage to the insured property. Having insufficient insurance coverage can harm you in two ways, whether you did it accidentally or on purpose. It can cause significant consequences that are the same in both cases.
• You won’t be able to get compensated for the complete amount of your loss.
• Your insurance company will use the “average clause,” which implies that your claim amount will be further reduced.
Further, your insurance provider may also decide to cancel your cover if you are underinsured. This can also make it harder for you to get insurance for your building and belongings from another company.

Case Study: Claim settlement under Fire Insurance

Hemant, a 42-year-old individual was the owner of a factory, manufacturing woollen 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 for protecting his stock. As the fire gutted half of the stock, Hemant contacted his insurance company to cover the losses incurred.

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.