Page 111 - W01TB8_2017-18_[low-res]_F2F_Neat

Chapter 7 Indemnity 7/9

Question 7.3
Following a fire in Kevin’s home, a picture, valued at US$7,000 at the time of the loss, was destroyed. If the total
sum insured was US$70,000, is it possible that Kevin would not receive full indemnity? Give reasons for your
answer.

E3 Average

We have said that, in property insurance, the amount payable by an insurer is limited to the sum insured
declared by the policyholder under the policy, and it is this figure that is used to determine the premium.
We have already seen that equitable premiums are central to the concept of pooling risks.
If, when taking out their policy the policyholder understates the value of the subject-matter of the
There is said to be
insurance, there is said to be underinsurance. The intention is that everyone who contributes to the pool underinsurance
pays a premium that is based on the full value of the subject-matter of the insurance. It would not be
equitable to accept a risk into the pool that is based on less than the full value, as the premium charged
would be too low. However, insurers cannot check that the sum insured is adequate every time they take
on a new risk. Instead, they limit their liability by applying a policy term known as the average condition.
In effect, this term means that the policyholder is considered to be their own insurer for the amount they
have chosen not to insure, if there is underinsurance at the time of any loss. It means that even partial
losses will be shared in proportion to the amount of underinsurance.

The formula used to calculate a claim payment, subject to the pro rata condition of average, uses the
sum insured, the value at risk and the loss, as follows:
sum insured × loss
value of goods at risk

The average condition is usual in commercial fire and theft policies and in virtually all household
policies. It cannot apply to liability insurances.
Example 7.4
Hugh Brown & Co. had a fire in their shop and claimed for a loss of US$1,200. The loss adjuster, instructed by the Reference copy for CII Face to Face Training
insurers, was satisfied that the loss claimed was correct but reported that Hugh Brown & Co’s accounts showed
that there was US$20,000 of goods in stock but only a US$16,000 sum insured under the policy. Therefore, they
adjusted the loss and recommended settlement as follows:
sum insured × loss
value of goods at risk Chapter
US$16,000 × US$1,200 7
US$20,000

Question 7.4

In what circumstances would an insurer pay the total sum insured under a policy, despite the application of average?

Sample examination question 2

Mr Smith’s garage buildings are valued at US$400,000 and insured for US$300,000 under a policy which is subject
to average. If he suffers a US$100,000 insured loss, how much will his insurers pay?
a. US$25,000. F
b. US$66,666. F
c. US$75,000. F
d. US$100,000. F

E3A Variations in conditions of average

The principle that losses will be paid in proportion to what the policyholder has decided to set as a sum
insured applies to most property insurance policies. However, insurers vary their approach in different
circumstances.