What is Average Clause in Fire Insurance?
Fire insurance is a contract between an insurer and the insured in which the insurer promises to protect the interest of the insured by indemnifying him from the actual loss of goods damaged by the incident of a fire. Sometimes, the insured purchases a partial insurance policy for certain goods. For example, if the value of machinery is INR 1,00,000 and the buyer may purchase the insurance policy to indemnify the losses up to INR 30,000. So the insurance company will only repay 30 percent of the losses by imposing the condition known as the average clause in the fire insurance policy.
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Calculation of Average Clause in Fire Insurance
It is essential to understand the calculation of the average clause in fire insurance in order to determine the liability of the insurer for the reimbursement of the claim.
The formula that the insurer generally uses to determine the value of an insured claim under the average clause in fire insurance could be denoted as:
Insured claim amount= (Actual loss x Insured value) / Actual value of property
In the formula mentioned above,
- Actual loss refers to the loss that has been incurred by the insured during the occurrence of fire.
- Insured value refers to the value for which the insurer purchased the fire insurance.
- The actual value of property refers to the total value of the property at the time or day of fire incidents. The actual value is determined after applying the appropriate depreciation on the insured property.
Calculation of Average Clause in Fire Insurance
It is essential to understand the calculation of the average clause in fire insurance in order to determine the liability of the insurer for the reimbursement of the claim.
The formula that the insurer generally uses to determine the value of an insured claim could be denoted as:
Insured claim amount= (Actual loss x Insured value) / Actual value of property
In the formula mentioned above,
- Actual loss refers to the loss that has been incurred by the insured during the occurrence of fire.
- Insured value refers to the value for which the insurer purchased the fire insurance.
- The actual value of property refers to the total value of the property at the time or day of fire incidents. The actual value is determined after applying the appropriate depreciation on the insured property.
Case Study
Let us discuss a case study in order to see how the average clause in fire insurance is determined.
Mr. Suresh, the 45 years old businessman, owns a factory manufacturing garments, which he caters to the shopper for business purposes.
One day, during the operation of a business, a fire engulfed his factory where he lost the stocks of garments that were ready to sell. He approached the insurer of fire insurance online and claimed the loss. The surveyor found the average clause in the fire insurance policy and discovered the value of the claim as follows:
Actual value: INR 4,00,000
Sum Insured: INR 3,00,000
Loss incurred: 2,00,000 (Since half of the stock caught fire)
Hence, on the basis of the average clause in a fire insurance policy, the surveyor determined the claim value by applying the formula mentioned above:
Insured claim amount= (Actual loss x Insured value) / Actual value of property
= (2,00,000 x 3,00,000) / 4,00,000
= 1,50,000
The insurer is liable to pay INR 1,50,000 while the insured has to bear INR 50,000
Conclusion
The average clause in fire insurance can be calculated by another method given below.
Value of goods: INR 1,00,000
Insured value: INR 30,000
Loss due to fire: INR 20,000
In this circumstance, INR 30,000 represents the value of goods which is 30 per cent of the total value of goods. The loss incurred due to the fire is INR 20,000 (20 per cent of the total value of the goods). Hence, the insurer will only pay 20 per cent of the insured value, INR 6,000. The remaining INR 14,000 will be borne by the insured.
