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Mathematics and Statistics · Ch 10 — Insurance and Annuity

Fire / Property Insurance and the Average Clause

4

Fire / Property Insurance and the Average Clause

The average clause is the single most important idea in property and fire insurance. It penalises under-insurance so that a policyholder who insures for less than the full value bears a proportionate share of every loss.

The average clause

If a property is insured for less than its full value, the claim admitted for a partial loss is reduced in the ratio of the sum insured to the property value:

 Claim=Sum insured (policy value)Value of property×Loss \boxed{\ \text{Claim}=\frac{\text{Sum insured (policy value)}}{\text{Value of property}}\times\text{Loss}\ }

The claim can never exceed the sum insured, nor the actual loss.

When the average clause bites — and when it doesn't

Note

Full insurance escapes the deduction

  • If sum insured == property value (or more), the ratio is 11 (or capped at 11), so the claim equals the full actual loss (up to the sum insured). The average clause makes no deduction.
  • If sum insured << property value, the ratio is less than 11, so the claim is a fraction of the loss — the policyholder is treated as "self-insuring" the uninsured part.
Tip

Reading the problem correctly …

Definition 1Average clause

For an under-insured property, Claim =sum insuredproperty value×loss=\dfrac{\text{sum insured}}{\text{property value}}\times\text{loss}; the claim is capped at the sum insur …

Definition 2Effect of full vs partial insurance

Sum insured ≥\ge property value ⇒\Rightarrow claim == full loss (no deduction). Sum insured << property value ⇒\Rightarrow claim is a proporti …

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