Average and coinsurance clauses - a hidden danger

Average/Coinsurance clauses

Hidden within the wordings of nearly all Business Insurance policies are clauses seeking to protect insurers from underinsurance by their policy holders. A clause may look like this one in a Business policy:

Underinsurance

In the event of Damage to the Property Insured We will be liable for no greater proportion of the Damage than the Sum Insured bears to 80% of:

a). where the Basis of Settlement is Reinstatement or Replacement, the reinstatement or replacement cost of the Property Insured;

b). where the Basis of Settlement is Indemnity, the value of the Property Insured, taking into account wear, tear and depreciation; on the day of commencement of the Period of Insurance.

Underinsurance will not apply if the amount of the Damage is less than 5% of the Sum Insured.

 Every Situation insured is separately subject to this clause.

 

Within an Industrial Risks policy the amount may be 85%, most Business Pack policies it is 80% while some property owner policies may be as much as 90%. Most will apply this clause if a claim is more than 5% of the sum insured with a few waiting until 10%.

Why do insurers have such clauses? Simply it is a way of discouraging Insureds from under insuring. It is hoped that if they are aware of this clause they will seek to update their sums insured regularly rather than rely on only suffering this shortfall in the event of a total loss. It is difficult to know that this actually has any affect on our clients.

In a real sense, if you are paying a premium based on a $750,000 sum insured but should have been paying a premium based on $100,000, then you have really only been paying for 75% of the risk. Why should you get 100% of any minor claim up to $750,000 when if it was a total loss you would have only got 75% then?

There is another way which is a Stop loss sum insured and some insurers use this to avoid problems with underinsurance. This acts like a sub-limit on policies where the policy will pay up to the sum insured limit. We find this process more commonly in Householder policies. The trouble with this is there is no incentive to make sure you are insuring for the full value of your risk even though you will be fully covered for any minor loss up to the sum insured. In theory would expect you would be paying more in premium to be covered fully for minor losses.

However with either type of cover, if you have a total loss, you are underinsured anyway if you have not insured for the full value. Our strong advice is to insure as much as possible for the full replacement value of your property. If you are under-insured by less than 15% of the full value, you should not be finding the Average Clause applying against your claim

 The Insurance Contracts Act 1984 makes provisions for how average is applied as follows:

 

44 Average provisions

(1) An insurer may not rely on an average provision included in a contract of general insurance unless, before the contract was entered into, the insurer clearly informed the insured in writing of the nature and effect of the provision including whether the provision is based on indemnity or on replacement value of the property that is the subject-matter of the contract.

 (2) Where the sum insured in respect of property that is the subject-matter of a contract of general insurance that provides insurance cover in respect of loss of or damage to a building used primarily and principally as a residence for the insured, for persons with whom the insured has a family or personal relationship, or for both the insured and such persons, or loss of or damage to the contents of such a building, or both, is not less than 80% of the value of the property, the liability of the insurer in respect of loss of or damage to the property is not reduced by reason only of the operation of an average provision included in the contract.

 (3) Where:

(a) the sum insured in respect of property that is the subject-matter of such a contract is less than 80% of the value of the property; and

(b) but for this subsection, an average provision included in the contract would have the effect of reducing the liability of the insurer in respect of loss of or damage to the property to an amount that is less than the amount ascertained in accordance with the formula

 AS/P

where:

A is the number of dollars equal to the amount of the loss or damage.

S is the amount of the sum insured under the contract in respect of the property; and

P is 80% of the number of dollars equal to the value of the property. the average provision has the effect of reducing the liability of the insurer to the amount so ascertained.

(4) In this section: value, in relation to property, means:

(a) if the relevant contract provides for indemnifying the insured in respect of loss of or damage to the property, the indemnity value of the property; or

(b) if the relevant contract provides for reinstatement or replacement of the property, the reinstatement or replacement value of the property; at the time when the relevant contract was entered into.

However this clause is judged, it is something very much to be aware of for any type of Property Insurance. We always advise our clients to be fully insured for all their property covers. From the insurer’s perspective, it is a protection for them against under-insurance. Some may see it as a way of encouraging more adequate insurance. One thing for sure though is that when you are helping to settle a claim for your client following a minor fire or for storm damage and the insurers advise your client is under-insured, if they apply the average clause we all end up frustrated and disappointed not being fully covered.

With the benefit of hind sight, make sure you are fully covered for your risks. It is worth paying the extra premium. 

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