A short term insurance policy usually includes a general ‘average clause’ to indemnify the insurer should the value of an insured item at the time of the loss turn out to be greater than that stated by the insured on the policy schedule. The clause is included in policy wordings as a specific condition for all policies in the fire and associated perils class. It is best to illustrate the average clause with an example:

Consider a set of drums insured by a musician on a personal all risks policy for R140,000 – a value provided by the insured to the insurer and recorded as such on a policy schedule. The drum kit is damaged while in transit and the musician receives a bill totaling R40,000 to repair it. Upon assessing the claim the insurer determines that the true replacement cost of the drum set is R200,000 (It should be noted here that the insurer calculates the replacement value of the policyholders personal goods as the cost to replace like-for-like with a new item)

The drum set is under-insured by 30%, calculated by dividing the difference between the sum insured and the replacement value. Due to the understatement of the insured value the insurer will apply the average clause and reduce its pay-out by the same percentage. The insured will thus only receive R28,000 (R40,000 – 30% or R12,000) as compensation for the damage to the drum set.

Had the entire drum set been stolen while in transit the insurer would have settled the total sum insured of R140,000, leaving the insured to make good on the remaining R60,000

It is therefore imperative that your limits of indemnity or sum insured/s are as near to replacement value as you can get.

Source: Short Term Insurance in SA 2016