Definition:Average clause
⚖️ Average clause is a policy provision commonly found in property insurance that penalizes policyholders for underinsuring their assets. When a property's sum insured is set below its actual value at the time of a loss, the average clause reduces the claim payout proportionally, so the insurer only pays the fraction of the loss that corresponds to the ratio of the sum insured to the true value. Also known as the "condition of average" or a "co-insurance clause" in some markets, it is a foundational principle in indemnity-based insurance contracts.
🔢 The mechanics are straightforward. Suppose a commercial building is worth $1 million but the policyholder has insured it for only $600,000. If a fire causes $200,000 in damage, the average clause applies the ratio of insured value to actual value — 60% — to the loss. The insurer pays $120,000 rather than the full $200,000, and the policyholder bears the remaining $80,000 as an effective self- retention. Some policies include a tolerance threshold (commonly 80% or 85% of value) below which the clause activates; if the policyholder maintains a sum insured above that threshold, the clause does not apply. Underwriters and loss adjusters evaluate the adequacy of declared values at inception and at the time of loss to determine whether the clause is triggered.
📌 For insurers, the average clause is a critical tool for maintaining the integrity of the risk pool. Without it, policyholders could systematically underinsure — paying lower premiums while still expecting full indemnification for partial losses, which would distort loss ratios and pricing adequacy across the portfolio. Brokers and agents play an important advisory role in ensuring clients understand the clause and maintain accurate valuations, particularly for commercial and industrial properties where asset values fluctuate. Misunderstanding the average clause remains one of the most common sources of dispute at the point of claim, making clear communication at the inception stage essential.
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