Average Clause

Average Clause in Fire Insurance Policy

To take care of cases of under-insurance, there will be an average clause in fire policy. This means that in case of loss the insured has to bear a part of the loss. The insurer will only bear rateable proportion of the loss. In other words, for the difference between the actual value of subject matter and the amount for which it is insured, the insured has to be his own insurer.

Let us illustrate, suppose a property worth Rs. 2,00,000 is insured for Rs. 1,50,000 and the fire policy contains the average clause. Now, if half the property is destroyed by fire, the insurer will pay only Rs. 75,000 which is calculated as per the following formula.

Insured amount (Rs.1,50,000) x Actual loss(Rs. 1,00,000) / Actual value of the property(Rs.2,00,000)

If three-fourths of the property is destroyed by fire, the insurer will pay Rs. 1,12,500. The entire amount of policy will become payable only when entire property is destroyed by fire.

Insurable Interest in fire insurance

In case of fire insurance, insurable interest should exist at both times, i.e., while taking policy and also at the time of suffering loss. The following persons have insurable interest in the fire insurance:

1. The owner of goods in his own goods.
2. The owner of the property in his property.
3. The agent in the goods of the principal.
4. The trustee in the ‘goods of the trust’.
5. The pledger in his pledged goods
6. The partner in the assets of the firm.
7. Fire insurance is a contract of indemnity. As a result, the owner of goods/stocks cannot claim more than the amount of actual loss sustained by fire. Under the circumstances, if the goods and/or assets are insured at a price which is either equal or more than the actual amount, the Insurance Company is liable to pay to the owner only the actual amount of loss sustained by fire and not more than that by way of compensation.
8. In order to maintain the interest of the Insurance Company from ‘Under-Insurance’, a condition is imposed what is known as Average Clause in the fire insurance policy. In this case, the Insurance Company is not liable to pay to the owner of goods the full amount of compensation for the loss of stock/assets sustained by fire.

• In other words, if the property/goods is under-insured, the insurer shall bear only that proportion of actual loss as his insurance bears to the actual value of property at the time of loss.

Thus, the same can be ascertained with the help of the following:

Amount of Claim = Actual Loss × Amount of Policy/ Value of Stock at the date of Fire