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⚖️ '''Average clause''' is a [[Definition:Policy | policy]] provision commonly found in [[Definition:Property insurance | property insurance]] that penalizes [[Definition:Policyholder | policyholders]] for [[Definition:Underinsurance | underinsuring]] their assets. When a property's [[Definition:Sum insured | sum insured]] is set below its actual value at the time of a loss, the average clause reduces the [[Definition:Claims | claim]] payout proportionally, so the insurer only pays the fraction of the loss that corresponds to the ratio of the sum insured to the true value. Also known as the "condition of average" or a "co-insurance clause" in some markets, it is a foundational principle in [[Definition:Indemnity | indemnity]]-based insurance contracts.

🔢 The mechanics are straightforward. Suppose a commercial building is worth $1 million but the policyholder has insured it for only $600,000. If a fire causes $200,000 in damage, the average clause applies the ratio of insured value to actual value — 60% — to the loss. The insurer pays $120,000 rather than the full $200,000, and the policyholder bears the remaining $80,000 as an effective self-[[Definition:Retention | retention]]. Some policies include a tolerance threshold (commonly 80% or 85% of value) below which the clause activates; if the policyholder maintains a sum insured above that threshold, the clause does not apply. [[Definition:Underwriting | Underwriters]] and [[Definition:Loss adjuster | loss adjusters]] evaluate the adequacy of declared values at inception and at the time of loss to determine whether the clause is triggered.

📌 For insurers, the average clause is a critical tool for maintaining the integrity of the [[Definition:Risk pool | risk pool]]. Without it, policyholders could systematically underinsure — paying lower [[Definition:Premium | premiums]] while still expecting full indemnification for partial losses, which would distort [[Definition:Loss ratio (L/R) | loss ratios]] and pricing adequacy across the portfolio. [[Definition:Insurance broker | Brokers]] and agents play an important advisory role in ensuring clients understand the clause and maintain accurate [[Definition:Valuation | valuations]], particularly for commercial and industrial properties where asset values fluctuate. Misunderstanding the average clause remains one of the most common sources of dispute at the point of [[Definition:Claims | claim]], making clear communication at the [[Definition:Policy inception | inception]] stage essential.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Underinsurance]]
* [[Definition:Sum insured]]
* [[Definition:Co-insurance]]
* [[Definition:Indemnity]]
* [[Definition:Valuation]]
* [[Definition:Property insurance]]
{{Div col end}}

Definition:Average clause - Revision history

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