What is an average clause in an insurance policy?

An average clause in an insurance policy is designed to ensure that the risk is appropriately shared between the insurer and the insured. This clause typically applies in property insurance and operates on the principle of indemnity, which means that the insurance payout will reflect the actual value of the insured item at the time of loss, ensuring that neither party benefits from underinsurance.

If the insured property is underinsured at the time of a loss, the average clause will reduce the payout based on the proportion that the insurance coverage bears to the actual value of the property. For example, if a property with a value of $100,000 is insured for only $60,000, the insured is considered to bear some of the risk, and the payout from the insurer will be reduced accordingly.

This mechanism encourages policyholders to insure their property for its full value, thus preventing the potential loss of insurance benefits due to underinsurance. It promotes fair treatment by ensuring that the insured receives an appropriate payout based on their level of coverage and matches the value of the risk they want to protect.