Question

Explain the average clause under ‘Fire Insurance Policy’ by giving an example.

Hint:

Average Clause = partial payment if sum insured is less than actual value.

Answer 1

The Average Clause is an important condition included in fire insurance policies to handle under-insurance.
It ensures that the insured does not claim the full amount if they have insured the property for less than its actual value.
According to this clause, if the sum insured is less than the actual value, the claim amount is reduced proportionately.
This prevents policyholders from paying lower premiums for under-valued cover and still expecting full compensation.
Example:
Suppose a factory building is worth ₹10,00,000 but the owner insures it for only ₹5,00,000.
A fire causes damage worth ₹4,00,000.
Applying the Average Clause: \[ \text{Claim Payable} = \left(\frac{\text{Sum Insured}}{\text{Actual Value}}\right) \times \text{Loss} \] So, \[ \text{Claim Payable} = \left(\frac{5,00,000}{10,00,000}\right) \times 4,00,000 = 2,00,000. \] Thus, only ₹2,00,000 will be paid by the insurer due to under-insurance.
The Average Clause encourages correct estimation of property value for adequate coverage.