What Happens When Something Is Under-Insured?

When you take out an insurance policy; you are required to explain the value of the property (or its contents) that you want to insure. This value is known as “the sum insured”. In some cases there will be a discrepancy between the value of the property and the value of the sum insured. If the value of the property is higher than the sum insured – this is known as “under-insurance”. Why? Because in the event of a total loss, the sum insured will not pay for the full value of the claim.

What Remedies Do Insurers Have for Under-Insurance?

At the time that any claim is made for property under an insurance contract, whether this is for a partial value of the whole sum insured or the entire value, an insurer may assess the value of that property as part of the claims processing routine.

If the insurer discovers that the claimant is “under-insured” they may, if there is a clause in the contract, “apply average” to the policy.

What Does “apply average” Mean?

This means that the insurer is allowed to reduce their pay out in the event of the claim in proportion to the amount under-insured.

Let’s take an example:

A policyholder insures their home and contents for £200,000.

They make a claim for £50,000 following a fire.

The insurer assesses the total value of the home and contents to be £250,000.

Thus the original policy was only for 80% (£250,000/£200,000) of the actual value.

Thus the payment made when the insurer chooses to “apply average” will be 80% of £50,000 which is £40,000.

Can an Insurer Automatically “apply average” to a Policy?

For most insurance contracts there will be an “apply average” clause. This does not mean that the insurer is automatically entitled to use that clause.

While a policyholder is required to estimate the value of their property to take out insurance, in most cases they will not hold any particular expertise in assessing value.

Thus it is important that the insurer firstly asks “what is the total value of the property and all of its contents?” Asking “how much do you want to insure?” is not enough. The policyholder might adjudge their maximum likely loss to be less than the total value, for example, and deliberately take underinsurance.

The insurance watchdogs will not allow an insurer to “apply average” if they asked the latter question rather than the former question. It is not fair to penalize a customer for failing to supply an entire amount when they were not asked to do so.

Secondly, even when the insurer asks “what is the total value of the property and all of its contents?” They must assist the customer in determining that value. The watchdog will examine whether they made it clear as to how the customer should reach the figure. If they did not – they are unlikely to be allowed to “apply average”.

The watchdog will also examine if the insurer was explicitly clear about what should be totalled for the estimate. For example, did they ask the insured party to state a total sum including items that might be insured on other policies?

It will take note of whether the insurer auto-calculated any values when forms were completed (it is hardly fair to penalize a consumer for the insurer’s estimate).

They may also take into account whether the insurer had appropriately index-linked the value of the claim at the time the policy was taken out. A customer’s home may rise substantially in value over a year – again it is unfair to penalize them for this rise, unless it was specifically excluded in the policy.

Finally, they may also look at how the application was made. If the insurer asked someone to fill in the forms online – could those forms be accurately completed without the guidance notes?

Insurers are required to act ethically and in many cases, it may be their fault to a greater or lesser extent that their customers are under-insured. They are not able to “apply average” when they are at fault.

Can an Insurer “apply average” Without an “apply average” Clause?

In general, the answer to this question is “no”. It’s not reasonable for an insurer to penalize a client with a concept not included in their contract.

However, in the case of “careless misrepresentation” or in the case where an insurer would have stipulated certain conditions which have not been adhered to because of under-insurance – the watchdog may allow the insurer to “apply average” as an alternative to voiding (cancelling) the policy.

In the case of “deliberate misrepresentation” by the insured party; the insurer may be allowed both to “apply average” and to seek redress for fraud.

When an Insurer “applies average” Does This Affect Policy Limits?

No, in the event that an insurer is allowed to “apply average” they must do so before applying any policy limit. Otherwise they would be allowed to reduce the total potential pay out for which they have already collected a premium.

One Last Thing…

Insurers with an “apply average” clause must make it clear during policy renewal that the client must update the value insured. If this was not made clear, it is likely that the “apply average” clause will not be enforceable with the watchdog.

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