What is average?

‘Average’ is a basic insurance principle applied to most property insurances. It is intended to ensure that the Insurer receives a fair premium for the risk and that adequately insured risks do not subsidise those that are under insured.

The ‘average’ condition applied to property insurance states that if the sum insured on that particular item is less than the full value, the amount of any payment under the policy will be proportionately reduced.

Generally cover for property is arranged on a ‘reinstatement’ basis, which simply means that any settlement will be on a replacement as new basis. Sums insured should reflect the reinstatement as new value and average will be applied accordingly.

How ‘Average’ Works

A policyholder has a building sum insured of £5,000,000 at the commencement of the insurance. An explosion causes damage of £300,000 to the building. It is subsequently found that the actual reinstatement value is £7,500,000.

The sum insured is two thirds of the actual value. The Insurer has received two thirds of the value at risk and consequently the insured will only recover two thirds of the rebuilding cost viz:-

(Loss x Sum insured) ÷ Reinstatement value = Payment

(£300,000 x £5,000,000) ÷ £7,500,000 = £200,000

This example demonstrates how important it is to ensure sums insured are adequate. At inception rebuilding costs should be carefully assessed and re-assessed on a regular basis (at least at each renewal). Building indices will give guidance to rises in rebuilding costs.

‘Day One’ Average

Many sums insured are calculated on a ‘Day One’ average basis. This arrangement can provide excellent coverage against inflation during both the reinstatement period and the policy period.

With a standard escalator index linking arrangement, the inflation factor is added on a gradual basis during the year. With ‘Day One’ it is all-available from the start of the period – i.e. ‘Day One’.

The Insured must select a ‘declared value’ at the commencement of the insurance. This figure should include architects/surveyors fees as well as debris removal costs and any allowance for a local authority requirement involving additional reinstatement costs. It is not necessary to make allowance for increased costs that may be incurred in both the reinstatement period and the next period of insurance. This figure constitutes the ‘declared value’. The sum insured available for settlement is the ‘declared value’ plus the inflation factor selected i.e.

Declared value = £1,000,000 Inflation factor, say 25% = £250,000 Sum insured = £1,250,000

Premium is calculated on an advantageous basis by discounting the inflation factor.

Other ‘average’ applications

Some buildings were constructed many years ago and would, in all probability, not be rebuilt in their existing manner, as modern, more appropriate, lighter, cheaper buildings would be preferable for the purpose used.

Complications arise in the event of a partial loss where costs may be more than the cost of rebuilding.

Additionally ‘listed’ buildings present difficulties as it may be necessary to reinstate in the existing manner as required by local authorities.

Some insurers may be prepared to provide coverage for these types of buildings on a more realistic basis with a modification of the average condition and reduced costs of insurance.

For further details please contact your account executive.

What is average?