Underinsurance and the Average Clause in a Fire Claim
Meera runs a hardware shop in Satara. She insured her shop building, furniture and stock for ₹12,00,000 with a standard fire policy. At the time of the proposal, the total value of the insured property was about ₹20,00,000, but she chose the lower sum to reduce the premium. In June a fire destroyed stock and shelving; the surveyor assessed the loss at ₹8,00,000, and damaged goods sold as salvage fetched ₹50,000. The policy has a ₹10,000 excess. The insurer says the claim will be reduced because of underinsurance. Meera argues that she paid the premium on ₹12,00,000 and should get the full ₹8,00,000 because the loss is less than the sum insured. The policy is on reinstatement value basis for building and furniture, but stock is on market value.
1. Calculate the amount the insurer is likely to pay and show the average-clause working.
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Use the average clause:
- Sum insured = ₹12,00,000; value at risk = ₹20,00,000 → 12/20 = 0.60 (60%).
- Net loss = ₹8,00,000 − ₹50,000 salvage = ₹7,50,000.
- Payable = 0.60 × ₹7,50,000 = ₹4,50,000.
- Less policy excess of ₹10,000 → ₹4,40,000.
So the insurer is likely to pay about ₹4.4 lakh, not ₹8 lakh. The salvage belongs to the insurer or is deducted; Meera cannot sell the damaged goods and also claim the full loss. If the policy wording makes the excess applicable only to certain sections, the deduction may differ, but the average-clause reduction remains.
2. Meera says she paid premium on ₹12,00,000, so she should get the full ₹8,00,000. Explain why the average clause applies and whether the loss being below the sum insured matters.
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The average clause is a condition of the fire policy, not a penalty. The policy promises indemnity - to put Meera back in the same financial position - but only in the proportion that her sum insured bears to the value of the property.
- The clause applies whenever the sum insured is less than the value at risk. It is not limited to total losses.
- Paying premium on ₹12 lakh does not buy ₹20 lakh of cover; it buys 60% of the risk. A loss smaller than the sum insured is still scaled down because the premium was based on an inadequate sum.
- If Meera had insured for ₹20 lakh, the calculation would be 20/20 × ₹7.5 lakh = ₹7.5 lakh, subject to policy terms and the excess.
Her argument confuses the sum insured with the actual loss. The insurer will apply the clause unless the policy has a special waiver or an agreed-value basis.
3. Advise Meera on fixing her insurance at renewal and on the records she should maintain.
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At renewal:
- Revalue the property: building and furniture on reinstatement basis, stock on market value. Use a professional valuation if needed.
- Set the sum insured at the full value; do not reduce it to save premium.
- Declare stock fluctuations, seasonal peaks and any new machinery; use a declaration or floater section if stock varies during the year.
- Check add-ons such as removal of debris, professional fees and business interruption, and confirm the excess.
- Confirm the basis of settlement for each section, because depreciation applies where reinstatement is not chosen.
Records to keep: purchase invoices, stock statements, photographs, the fire brigade report, the surveyor's report and salvage sale records. These support both the claim and the valuation. Underinsurance saves a small premium but costs a large proportion of every claim.