Average/Coinsurance or Under-insurance clauses - What are they?

One of the reasons we advise against Under-insurance is that in the event of a total loss, you will not have enough to fully reinstate or re-build or replace your property. But what happens if you only have a minor loss? Is this factored into how the claim is calculated? Many insurers will rely on an Average Clause also sometimes called a Co-insurance clause or an Under-insurance clause.

You should make sure first that you have such clauses in your policies and secondly, their implications.

For most Business Insurance policies, the answer is yes. However, the majority of Householders policies these days do not have average/coinsurance/underinsurance clauses.

Insurers have these clauses firstly to encourage full insurance coverage but as a protection for themselves if they are only partially covering a risk. Their argument is that they are expected to cover a risk but if it is not fully insured, then they have not collected all the premium needed for not just a total loss, but also for a partial loss. For a partial loss should they be expected to pay the full cost of repairs when they have not received all the premium to cover the risk fully?

If they did, we would call it a "stop loss" cover and the premiums are generally higher for this type of cover than ones incorporating the Average/Coinsurance or Under-insurance clauses.

The following provides:

  • The relevant clause in the Insurance Contracts Act
  • A typical warning found in an Insurer's proposal form 
  • A typical clause found in an Insurer's policy wording (PDS)

The 1984 Insurance Contracts Act imposes the following requirements on Insurers relating to the use of Average/Coinsurance/Underinsurance clauses

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.
 

 

Proposal forms will have warnings about their Average or Coinsurance clauses such as this one


A co-insurance (average) clause applies to the Property, Business Interruption and Electronic Equipment Sections of this Policy.
This means that if the Sum Insured for:

  • any items of Property insured under the Property Section; or the Gross Income insured under the Business Interruption Section; or any item of Electronic Equipment insured under the Electronic Equipment Section
  • is less than 80% of its value at the time you take out this Policy and at each renewal of the Policy, then for any loss or damage You will be Your own in surer forthe difference, that is You will bear a rateable proportion of each claim in accordance with the following formula.

Sum Insured x Amount of loss or damage 80% of value = Amount Payable (up to Sum insured)
 

A typical average clause 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.

This clause does not apply to additional benefits 1. to 7.inclusive, 11. and 13. 

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