Average Clause

The average clause (also known as the condition of average or pro rata condition of average) is one of the most consequential policy conditions in Indian commercial insurance, yet it is frequently misunderstood by policyholders. It operates as an enforcement mechanism for the principle of indemnity by ensuring that if a business insures its property for less than its full value, it effectively self-insures the difference and must bear a proportionate share of any partial loss.

The formula is straightforward: claim payable = (sum insured / actual value at time of loss) x loss amount. If a factory worth INR 10 crore is insured for only INR 6 crore and suffers a partial fire loss of INR 2 crore, the insurer applies the average clause and pays only INR 1.2 crore (6/10 x 2 crore). The policyholder bears INR 80 lakh as a penalty for under-insurance.

In Indian commercial insurance, the average clause is a standard condition in the Standard Fire and Special Perils (SFSP) policy, engineering insurance policies, and property insurance policies. It applies to each item of the policy schedule separately -- buildings, plant and machinery, stock, furniture, and other contents are each assessed independently for under-insurance. This is particularly relevant for Indian businesses where rapid asset appreciation, capacity expansions, or stock fluctuations can cause the sum insured to fall below actual values without the policyholder realising it.

To protect against the average clause, Indian businesses can adopt several strategies. The reinstatement value clause insures assets at replacement cost rather than depreciated market value, eliminating one common source of under-insurance. Declaration policies, commonly used for fluctuating stock, allow the insured to declare values periodically (monthly or quarterly) and adjust the premium accordingly, ensuring the sum insured tracks actual stock levels. The special condition of average (also called the 85% condition) provides some relief by applying average only when under-insurance exceeds 15%. Indian insurance brokers routinely advise clients to conduct annual asset revaluations and stock audits to ensure adequate sums insured and avoid the punitive impact of the average clause during claims.