Most people believe that if something is insured, it is fully covered. Unfortunately, that is not always true.
If your home, contents or business assets are insured for less than their true replacement value, insurers apply what is called the average clause. This can significantly reduce your claim payout, even when the loss is only partial.
What Is Underinsurance?
Underinsurance happens when the sum insured on your policy is lower than the actual cost to replace the property or asset. This can apply to:
Personal Insurance
• Residential buildings
• Household contents
• Portable possessions
Commercial Insurance
• Buildings
• Tenant improvements
• Contents and equipment
• Stock
• Machinery
• Business Interruption
How The Average Clause Works
When you are underinsured, insurers apply a proportional calculation to determine the claim payout.
Claim Payment = (Sum Insured ÷ True Value) × Loss Amount
In simple terms, if you insured your property for only a percentage of its true value, the insurer will pay that same percentage of your claim. This does not only apply to total losses. It applies to partial losses as well.
Personal Insurance Example
Scenario
Actual replacement value of home: R3,000,000
Sum insured: R2,000,000
Fire damage claim: R600,000
Calculation
R2,000,000 ÷ R3,000,000 = 66.6%
66.6% × R600,000 = R400,000 payout
The remaining R200,000 must be funded personally, and the excess still applies.
Household Contents Example
Household contents insured for R550,000
Actual replacement value R820,000
A fire destroys all contents.
R550,000 ÷ R820,000 × R550,000 = R368,902 payout
Even though the loss was significant, the payout is reduced because the contents were underinsured.
Commercial Insurance Example
Restaurant contents actual value: R10,000,000
Insured for R7,000,000
Equipment damage claim R1,000,000
R7,000,000 ÷ R10,000,000 = 70%
70% × R1,000,000 = R700,000 payout
The business must cover the R300,000 shortfall, plus the excess. This can place immediate pressure on cash flow.
Why Underinsurance Happens
Underinsurance often happens gradually. Common causes include:
• Rising building costs
• Inflation
• Renovations that were not declared
• New equipment purchases
• Increased stock levels
• Using book value instead of replacement value
Business Interruption cover is also frequently underestimated. Incorrect turnover figures, inaccurate gross profit percentages or an insufficient indemnity period can leave a business exposed long after physical repairs are completed.
How To Reduce The Risk
• Review your sums insured annually
• Adjust for inflation
• Update values after renovations or equipment purchases
• Confirm replacement value, not depreciated value
• Ensure tenant improvements are included
• Check maximum stock levels
Insurance works properly when the values are accurate. If you are unsure whether your home or business may be underinsured, we can review your policy and help you assess whether adjustments are needed.
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It is far better to correct a policy now than to discover a shortfall during a claim.
This content is provided for general information purposes only and should not be considered financial advice. Please consult a qualified financial adviser before making financial decisions.
