Sometimes, it’s generally seen as okay not to read the fine print – who has the time to trawl through every word of a streaming service update or the terms of app permissions? 

But when it comes to building insurance, it’s time to break out the magnifying glass, because something called the “average clause” is lurking and when unaccounted for, it can lead to a world of financial woes.

What is an average clause in insurance?

Although the average clause tends to be buried under an abundance of additional fine print and jargon, it can completely change the payout of a future claim.

In insurance, the average clause (also known as an underinsurance average clause) is a provision applied by policy providers that means, if a building is insured for only a proportion of its value, for example half of its rebuild value, the insurer is only liable for the same proportion of the loss. It’s a jarring thought, but it’s important to note that the average clause can only be invoked when a property is underinsured.

How does it work?

If you file a claim, the payout is reduced proportionately to the level of underinsurance. For example, if you insure a property for half its actual reinstatement cost, any claim will only be paid out at 50% of the claimed amount.

What is the purpose of the average clause?

The average clause in insurance claims may seem strange, but there is sense to it. This clause exists to ensure the policyholder bears a fair share of the risk when they choose to – or inadvertently – underinsure their assets.

It’s also a way for the insurance company to recoup the cumulative losses incurred due to the policyholder paying lower premiums up until the point of the claim.

In essence, you can think of the average clause as fair warning not to risk underinsuring your property. To avoid being stung by the average clause in your policy agreement, it’s crucial to insure your property for its true value.

What is the “true value” of my property?

Generally speaking, as claims will be made in the event of damages or total property loss, when it comes to the average clause, rebuild cost is used as the “true value” of your property.

But we’d still advise discussing exactly what is meant by the language used in your insurance documentation with the policy provider before signing on the dotted line.

Understanding the average clause equation

Thankfully, the average clause is relatively easy to understand in equation form:

(Insured amount / rebuild value) x claim = penalty)

Now let’s put it to work in an example:

• Your property’s true reinstatement cost is £200,000
• To save on premiums, you only insure it for £100,000 (50% of the actual value)
• Your property suffers a fire and you make a claim for the £50,000
• Your policy provider invokes the average clause and does the math – 100,000 / 200,000 = 0.5
• 5 x £50,000 = £25,000
• The policy provider reduces the payout by 50%, meaning you only receive £25,000, leaving you £25,000 out of pocket

Got it… but what’s the 85 average clause?

You may also have heard of the 85 average clause, especially in relation to property insurance. This is simply a more forgiving variation of the standard average clause discussed above.

With the 85 average clause (also known as the 85% average clause or the co-insurance clause) the policyholder is required to insure their property to a minimum of 85% of its value, leaving 15% underinsurance leeway before penalties can be issued and payouts reduced.

Let’s look at an 85 average clause example:

• • Your property is valued at £1,000,000
  • You are required to insure it to the value of £850,000 (85% of the total value)
  • You insure the property for £700,000
  • This makes the insured ratio 0.8235
  • Your property is damaged, and you make a claim for £100,000
  • The insurer reduces the payout proportionally based on the ratio
  • You receive £82,350

Role of Reinstatement Cost Assessments (RCA)

Reinstatement Cost Assessments are are an essential insurance risk service that play a critical role in determining the insured value of a property.

These assessments involve detailed evaluations to estimate the cost of rebuilding or replacing the property in case of a total loss. Factors considered include construction costs, materials, labour and other expenses necessary for reconstruction.

Importance in avoiding penalties

1. Accurate coverage: Conducting periodic RCAs ensures that the insured value aligns closely with the property’s current reinstatement cost. This helps mitigate the risk of underinsurance, where the insurance coverage may not be sufficient to cover the full cost of rebuilding or replacing the property.
2. Claims settlement: In the event of a claim, insurers compare the insured value to the property’s true value as determined by the most recent RCA. If the insured value is less than the true value, the insurance payout may be reduced proportionally based on the underinsurance ratio.
3. Risk Management: By maintaining accurate and up-to-date RCAs, policyholders can effectively manage risks associated with underinsurance and ensure that their insurance coverage adequately protects their financial interests in the event of a loss.

Protect against underinsurance with Cardinus

Cardinus is a RICS-regulated provider, backed by a team of highly experienced surveyors who operate nationwide, bringing valuable local knowledge to every project. More than 80% of properties we assess are underinsured, and our services have corrected over £9 billion of underinsurance over the last three years.

Don’t leave your property’s insurance to chance, contact us or email [email protected] to hear how we can safeguard your property against underinsurance.