Condition of average

Condition of Average

Diagram illustrating the Condition of Average

The Condition of Average is a principle in insurance that applies to property insurance policies. It is a clause that requires the policyholder to bear a proportion of any loss if the insured property is underinsured. This principle is designed to encourage policyholders to insure their property for its full value.

Explanation

The Condition of Average is typically expressed as a percentage, such as 80% or 90%. This percentage represents the minimum amount of insurance that must be carried in relation to the value of the property. If the insurance coverage is less than this percentage, the policyholder is considered to be underinsured and will be responsible for a portion of any loss.

For example, if a property is valued at $100,000 and the Condition of Average is 80%, the property must be insured for at least $80,000. If the property is insured for less than this amount, the policyholder will have to share in the loss proportionately.

Calculation

The amount of the loss that the policyholder must bear is calculated using the formula:

\[ \text{Claim Payment} = \left( \frac{\text{Amount Insured}}{\text{Value of Property} \times \text{Condition of Average}} \right) \times \text{Loss Amount} \]

This formula ensures that the policyholder shares in the loss in proportion to the amount of underinsurance.

Example

Consider a scenario where a property is valued at $200,000, and the Condition of Average is 80%. The property is insured for $120,000, and a loss of $50,000 occurs.

The required insurance amount is $200,000 _ 80% = $160,000.

Since the property is only insured for $120,000, which is less than $160,000, the Condition of Average applies.

The claim payment is calculated as follows:

\[ \text{Claim Payment} = \left( \frac{120,000}{160,000} \right) \times 50,000 = 37,500 \]

Thus, the policyholder will receive $37,500 from the insurer and will have to bear the remaining $12,500 of the loss.

Importance

The Condition of Average is important because it ensures that policyholders carry an adequate amount of insurance relative to the value of their property. It prevents situations where policyholders underinsure their property to save on premium costs, which could lead to significant financial losses in the event of a claim.

Related pages

• Insurance
• Property insurance
• Underinsurance
• Insurance policy