Under Insurance and the Condition of Average

This post deals with under insurance and the Condition of Average as they pertain to a Domestic Household policy which a normal person has on their own home.

The Condition of Average is present in most if not all Household policies. What the condition does is reduce the amount of payment you receive in the event of a claim if it is found the total sum insured is not sufficient to cover the total value at risk. This can be a major problem if you make a claim, and the effect it can have on your settlement payment is not always what you might expect.

The easiest way to explain it is by way of an example.

Mr and Mrs Jones have a standard 3 Bedroom house in a small town in the midlands. The property is quite close to a river and one day the banks burst and flood the house. The Jones's have £10,000 of Contents cover and a flood excess of £350. 

When the claim is examined it turns out that the Jones's actually have £20,000 worth of contents in their house. Accordingly the Insurer applies the Condition of Average to their policy. 

At this point we know two things the Jones's the Jones's have been flooded and their contents are worth 100% more than they have Insured them for.

A loss adjuster is sent to examine the claim for the Insurer. 

He concludes that the Jones's claim  amounts to £5,000 that is to say that the total value of items within the home which have been damaged is £5,000 and that they have an additional £15,000 worth of undamaged goods.  

Okay so now we know that the Jones's have £10,000 worth of insurance cover, the total value of their goods is £20,000 and the amount of their loss/claim is £5,000. This is the point at which a lot of people become confused as to how much money their policy entitles them to.

Your average person will assume that as the Jones's are only claiming for £5,000 and have £10,000 worth of cover the fact that they own goods worth £20,000 is irrelevant. Unfortunately it does not work that way.

The Insurance which the Jones's have taken out is issued (in 99% of cases) on the bases that the sum insured (£10,000 in our example) is the total value of goods in the house.

What I mean by this is that the policy has been issued, and premium quoted for on the basis that the value of the goods is 100% of the value at risk. In reality the Jones's have only received a quote on a 50% basis as they actually have £20,000 worth of goods not £10,000.

As the Jones's have not suffered a 100% loss (a total loss of all goods in the house) we have to run the average calculation. This calculation is not privileged information and is an industry standard.

Now lets continue to work the example.

So the loss Adjuster has to now take the Sum Insured (£10,000) divide that by the actual value at risk (£20,000) and then times that by the total loss (£5000). This gives the loss adjuster the adjusted settlement figure. 

Here it is as a sum

Sum Insured (£10,000)
----------------------    x Total Loss (£5000)   == £2,500 Minus policy excess of £350  
Value at Risk (£20,000)

Total payment to Mr and Mrs Jones is £2,150. 

So on this occasion Mr and Mrs Jones will receive a cheque for £2,150. It should be noted that the policy excess is deducted from the adjusted figure, not the total loss figure. What is immediately clear is that the Jones's now have a significant shortfall between the cost of the damaged goods and the amount of money their policy entitles them to.

One thing I want to make very clear, as I have to fight with Policyholders on this issue quite regularly,is that this is not the Insurer being bad, or trying to wriggle out of payment as much as people want to believe this.
The only person you can blame if you are affected by an average adjustment is yourself.

I say this because when you take out your policy you tell the Insurer how much the stuff in your house is worth. The Insurer then calculates your Premium based on this information. If you deliberately do not tell them a high enough figure to secure a lower premium or you do not bother to properly consider the value of your contents you will, at some point, be bitten and probably shout at the Loss Adjuster when you are to blame. Always remember the Insurer is not psychic  when you call or log onto the internet to buy your policy they ask YOU what your stuff is worth its entirely up to you to make sure you tell them the right figures.

Don't let this condition catch you out, check your policies if you think your Contents are worth more than what the policy sum insured says then call your Insurer and increase the cover. Otherwise at some point you may make a claim and end up very short of cash.

The only time you will receive the total amount of your sum insured if you are under insured is if you suffer a total loss. So say the Jones's house burns down to the ground and everything is gone. In that scenario they would get £10,000 on the basis there goods are actually worth £20,000. Again they would have a huge shortfall despite the Insurer paying out in full.

Be careful because this can happen to you if you are not careful and I have been to peoples houses who have lost everything and had to tell them that they are going to be very short money wise. People usually only think about big things, furniture, carpets electrical goods etc. But the Insurer is issuing the policy based on the value of everything, you do not get to pick and choose which items under the policy are Insured. Remember to consider the value of your clothes, jewelry, art, furniture, tools, cutlery basically anything that is not nailed to a wall.

 The same condition can affect Buildings claims as well, so for the same reasons make sure that your Buildings Sum Insured is how much the estimated rebuild cost of your property is. Please note your Buildings Sum Insured should be the Rebuild cost of your property not the Sale price of your property.

If you are not sure about the rebuild cost of your property go here ABI to the Association of British Insurers website they have a rebuild calculator which can help you work out if your level of cover is sufficient.

 Increasingly I am seeing Insurers issuing Buildings policy on a "no limit" basis. This means that as long as you are honest with the Insurer about what type of building you have at inception you do not need to declare the rebuild value as the policy has no cover limit. But check your policy and make sure you have the right cover.