Broker Tip #8: How Does The Average Clause Work?

Broker Tip #8: How Does The Average Clause Work?

What is under insurance and how do we avoid being under insured?

Many South Africans assume that if they have a home contents insurance policy in place, they will be covered if any of their possessions are lost, stolen or damaged. The same applies to commercial interests who have insured their business equipment. What they don’t realise, is that if these possessions are not insured at their replacement value they could have to cough up – even if they have been diligently paying their insurance premiums every month for years.

Definition of Underinsurance and the principle of “Average”

Underinsurance can be best defined as a situation in which your insurance cover – the amount your insurance policy will pay out in the case of a loss and subsequent claim – is less than what it would cost to replace the lost items. This obviously means that while your insurance pay-out will help towards replacing your losses, you will have to partially fund this replacement.

We could also describe underinsurance as the occurrence when there is a shortfall between the amount of cover selected and the actual replacement value of what is being insured. The result is that you will only be paid a proportional part of your claim. In the event of a claim, the principle of ‘average’ would be applied.

The formula determining average is as follows:
(Sum Insured / Value at Risk) x Amount of Loss


Let’s say Keith’s townhouse is insured for R500 000, but it’s actually worth R1 million. One day, while Keith is at work, an electrical fault causes the entire complex to burn down and he puts in a claim with his insurer for the total loss of R1 million. Keith’s claim is successful, but he only receives only R500 000, as his Sum Insured was only 50% of the actual value of his property. 

Similarly, if the damage to Keith’s apartment had been worth R100 000, he would only have received a R50 000 payout.

What is the replacement value of goods?

It’s also important to understand the term replacement value

The replacement value of goods is what it would cost you, at the time of a claim, to replace all your belongings with similar brand-new ones. If you submit a claim, your insurer will calculate the replacement value you should have insured yourself for. If you insured your belongings for less than that, your insurer will only pay a part of your claim.

Why would a person be underinsured?

Many clients are just not prudent when it comes to updating their policies and inventory lists. This is probably the most common sort of underinsurance encountered. Or sometimes, it’s just too expensive to insure items to their full replacement value.

A few suggestions on how to prevent being under insured:

Keep in mind that the replacement values of goods change over time.
You – or an expert – need to make a realistic estimate of the true replacement value of your insurable assets, equipment etc.
Update your household inventory list or other list of assets on a regular basis to ensure that any new items are included and to remove items that that you no longer have.
Pay special attention to specialized items where specialized insurance is required.

We would like to suggest more communication between clients and their brokers or insurance companies. Short-term insurance shouldn’t be an off-the-shelf purchase. You need to review your financial needs regularly to avoid nasty surprises should you have rely on your insurance policy.