IRDAI License Number: IRDAI/INT/ISNP/2022/250
In under insurance cases, the insurance company applies the average clause to the claim amount calculation. Underinsurance simply means insuring an asset for a lesser amount than the actual value of it. Insurance terms ‘pro-rata’ or the average clause means that claims are paid out according to the proportion of insurance taken on the value of the policy.
To give an illustration on it, suppose that a factory owner takes out INR 50 crore worth of insurance on his factory. The factory is actually valued at INR 100 crore. Unfortunately, a fire subsequently breaks out in the factory middle of the night, causing INR 50 lakh worth of damages and loss. The claim is made to the insurance company to recover the loss amount. The surveyors investigate and the report says the cause of the fire due to an insured peril. The insurance company starts processing the claim amount.
If the schedule of the policy mentions the pro-rata condition of average clause then the insurance company is only liable to pay in proportion to the level of insurance relative to the value of the property. Since the insurance policy only covers half the value of the property (INR 50 crore / INR 100 crore), the insured can only recover half - the cost of damage incurred– INR 25 lakh in this case which applies condition of average to the insurance policy.
Many a time policyholders are not aware of the actual value of the asset when insuring the same. Hence in an event of loss or damage if it is found that the value of sum insured is less than the actual required to be insured then the insured gets penalised and has to bear the difference amount of the difference in the proportion of insured amount and actual value of the asset. In under insurance covered up to 15% clause if the insured amount is even up to 85% of the value of the item then the insured may get the actual amount of claim and the condition of average will not be applied to the claim amount.
For example – A businessman gets insurance policy for his warehouse for sum insured of INR 85 lakhs. In a few months, part of the warehouse catches fire and assets worth INR 10 lakhs are lost. The policyholder files and claim with the company. The company finds out that the actual value of the warehouse is INR 1 crore. Since the shortfall is only 15% the insurance company does not apply the condition of the average clause to the claim and passes the claim amount.
Hence it is absolutely necessary to go through the policy wordings and understand the terms of insurance when buying an insurance policy. Any confusion or ignore on part of the policyholder can prove costly during claim settlement. The value of assets and property need to be checked before insuring them as under insurance and over insurance can both result in heavy losses and unnecessary expenditure for the business.
