Insurance policies are designed to provide financial protection when unexpected events occur, but understanding the fine print is crucial to ensuring you’re fully covered. One critical element found in many insurance policies, particularly in property and business interruption insurance, is the Average Clause.
If you’ve heard of this clause but aren’t quite sure how it works, or how it might affect your claims, this blog will clarify everything you need to know.
What Is an Average Clause?
An Average Clause is a provision in an insurance policy that reduces the amount of a claim payout if the insured asset is found to be underinsured at the time of a loss. The purpose of the clause is to ensure that policyholders declare accurate values for their insured property, reflecting its full reinstatement cost.
Essentially, it penalises underinsurance by requiring the insured to bear a proportion of the loss based on the level of underinsurance.
How Does the Average Clause Work?
The Average Clause is triggered when the sum insured (declared value) is less than the actual reinstatement cost of the asset. The claim payout is then reduced proportionately to reflect the shortfall in coverage.
Let’s assume:
- The actual reinstatement value of your property is £2,000,000.
- You insured the property for £1,000,000.
- A fire causes damage amounting to £500,000.
Under the Average Clause, the payout is calculated as follows:
- Insured Amount / Reinstatement Value * Damage Amount
- In this scenario, the formula word apply as follows:
- £1,000,000 / £2,000,000 * £500,000
This means that you would only receive £250,000, leaving you to cover the remaining £250,000 yourself.
Why Does the Average Clause Exist?
The Average Clause exists to:
- Encourage Accurate Valuation: By requiring policyholders to insure their assets at their full value, the clause ensures that insurers collect premiums proportional to the risk they are covering.
- Prevent Unfair Premiums: Without the Average Clause, policyholders who underinsure their assets would pay lower premiums while potentially receiving the same payout as those who insured their assets accurately.
- Balance Risk Distribution: The clause discourages underinsurance, which could otherwise lead to financial strain on insurers and other policyholders.
Common Scenarios Where the Average Clause Applies
The Average Clause can come into play in several situations, such as:
- Property Insurance: If you undervalue your building or equipment, you may face reduced payouts in the event of a claim.
- Business Interruption Insurance: If you underestimate your gross profit or turnover, the Average Clause can result in reduced compensation for lost income.
- Marine Cargo Insurance: Underestimating the value of goods in transit can lead to proportionate claim reductions.
How to Avoid Being Caught by the Average Clause
Avoiding the pitfalls of the Average Clause requires proactive measures to ensure that your insured values are accurate and up-to-date. Here’s how you can protect yourself:
1. Undertake Professional Valuations
Engage a qualified surveyor or valuation expert to assess the full reinstatement cost of your property or the accurate value of your assets. This ensures your declared sum insured reflects the true value.
2. Account for All Costs
When insuring property, include not only the building’s reinstatement cost but also associated expenses, such as:
- Demolition and debris removal.
- Local authority fees.
- Professional fees (e.g., architects, surveyors).
3. Review Your Policy Regularly
Values can change over time due to inflation, market fluctuations, or property improvements. Regularly review and update your insurance policy to ensure it remains accurate.
4. Consider Day One Cover
Many insurers offer Day One Uplift policies, which provide a buffer (e.g., 15-20%) above the declared value to account for inflation or unforeseen increases in costs. This can help mitigate the risk of underinsurance.
5. Consult Your Broker
Work with an experienced insurance broker who can help you understand the specifics of your policy, including the Average Clause and recommend solutions to avoid underinsurance.
The Consequences of Ignoring the Average Clause
Failing to address the Average Clause can have severe financial consequences. In the event of a claim, the reduced payout may leave you unable to cover the full cost of repairs, replacements, or business recovery. For some businesses, this shortfall can lead to significant financial strain or even closure.
The Average Clause is a critical component of many insurance policies, designed to promote fairness and ensure accurate risk assessment. However, its implications can be severe if you are not adequately insured. By understanding how it works and taking steps to ensure your declared values are accurate, you can avoid unpleasant surprises at the time of a claim.
At Sustain Insurance Brokers, we specialise in helping businesses navigate complex insurance terms and ensure they are fully protected. If you’re unsure whether your policy includes an Average Clause—or if you’re adequately insured—contact us today for expert advice and a policy review.
