Underinsurance and the Average Clause

What is underinsurance?

Underinsurance is when an individual or business has insurance coverage that is insufficient to cover the full extent of their losses. 

Underinsurance can occur when an individual purchases a policy with too low of limits, fails to update their policy as their needs change, or makes a claim for damages that exceed their policy limit. 

Underinsurance can also occur when a business purchases a policy that does not cover all of its potential risks. This can have serious consequences, including financial hardship and the inability to fully recover from a loss.

How does underinsurance happen?

Underinsurance can happen for a number of reasons. It may be that the insured doesn’t fully understand their coverage, or that they’re not aware of all the potential risks they face. 

In some cases, people may intentionally under insure in order to save money on premiums. However, this can be a risky strategy, as it may leave the policyholder without adequate coverage if they need to make a claim. 

Underinsurance can also occur when a policy is not properly updated to keep pace with inflation or changes in the insured’s circumstances. 

What is the average clause?

The average clause is often added to insurance and can be found in the small print of your insurance documents.

The average clause is a way of insurers paying out less than they need to if a policyholder is paying less than the premium they should be because they have inadequate cover.

Insurers apply the average clause and only payout a proportionate amount for what you are claiming based on how much you are underinsured by.

The average clause is there to ensure that policyholders declare the proper value of their goods and so pay the correct premiums.

What happens if I’m underinsured?

Underinsurance can have a number of consequences. If you are underinsured, you may not be able to make a claim for all of the damage that has been done to your property. 

This could leave you with a hefty bill to pay for repairs yourself. 

Underinsurance can also invalidate your insurance policy, meaning that you will not be covered at all if something goes wrong. This could leave you facing financial ruin if you need to make a claim.

Your insurer may apply the average clause to your claim meaning the payout could be considerably less than your claim.

Example One:

A contractor buys machinery for £10,000 (second-hand) so they insure it for the same value however if they need to claim on the insurance they aren’t able to get that specific piece of machinery for £10,000, brand new the machinery would be £15,000 then they are underinsured by 1/3rd.

The insurer could then apply the average clause and only pay out 2/3rds of the £10,000 claim minus the policy excess amount. This makes the payout significantly less than the £15,000 required to replace the machine.

Example Two:

If you value and insure your property at £300,000, but the true cost to rebuild it is £600,000 then you would be effectively underinsured by 50%. So if you made a claim for damage say for £100,000 your insurer would only pay out half of your claim so £50,000 then minus your policy excess potentially leaving you seriously out of pocket.

Many property owners associate the market value to be the value they need to insure their building for, which unfortunately isn’t the case.

It is recommended that you review the cost of rebuild of your property every year to ensure the value it is insured for has kept pace with inflation.

If your insurer believes that you underinsured your property on purpose to reduce the cost of your premium then it can refuse to pay out at all and can cancel your policy altogether.

Who can be affected by underinsurance?

Underinsurance can happen to any insurance policy. Whether its property, buildings, contents, business or vehicle insurance so it’s important to make sure you fully understand the value of what you are insuring. 

How to make sure your fully covered

For residential properties you can use the ABI Rebuild Cost Calculator to work out the cost to to rebuild your house.

Falcon Insurance also offer a Rebuild Valuation Service assessment service available for both residential and commercial customers which works out the costs for you ensuring you get the correct insurance. This service costs £137.50 inc VAT.