Average is a method by which under-insurance is defeated. The norms of insurance demand that there should always be full value insurance. Under-insurance deprives the insurers in getting the actual premium even though they are liable to pay the loss to the fullest extent, only limit being the sum-insured. The result being that the experience gets unfavorable leading to enhancement of the premium to the detriment of even those who always believe in full value insurance. To take care of such a situation average has been introduced to make the insured his own part-insurer to the extent of under-insurance.
Liability of Insurer = (Sum Insured x Loss)/ Full value
There are three types of average in practice. These are :
(a) Pro-rata Condition of Average : As per this type of average, if at the time of loss it is found that the actual value of the property is more than the sum-insured then the insurers will pay that proportion of the actual loss that the sum-insured bears to the actual value.
For Example :
Actual value ……………………..$20000
Policy pays…(10000×1000)/20000= $500
(b) Special Condition of Average: This is also known as 75% condition of average,. Under this type of average if at the time of loss it is found that the sum-insured is less than 75% value of the property then the insurers will pay that proportion of the loss that the sum-insured bears to the actual value. If the sum insured is at least to the extent of 75% (or more) of the actual value then no average applies.
Sum-insured …….$ 7500
Actual value …..$ 10000
Loss ………………. $ 1000
Policy pays ……..$ 1000
Example 2 :
Sum-insured….. $ 7000
Actual value ….$ 10000
Loss……………… $ 1000
Policy pays (7000/10000) x 1000 = $ 700
This condition is usually applied to those types of properties (e.g., stock) where there is a possibility of violent fluctuation in price rapidly.
(c) Two-Condition of Average: This is virtually nothing but a pro-rata condition of average when becomes applicable. It has two parts. The first part is exactly the pro-rata condition of average. The second part says that if at the time of loss it is found that there is a more specific policy covering the same loss then that specific policy shall pay the loss first and if there is still a balance of claim left then only this policy shall come forward to pay the balance loss and in case of under-insurance average shall apply in the usual manner on the balance,
Policy A – Sum-insured…. $ 1000 Property I & II (2c of AV)
Policy B – Sum-insured…. $ 700
Value : Property I ………$ 1000
Property II ……..$ 1000
Loss : Property I …………$ 500
Policy B pays first=$ 500 (as sum-insured fully covers the loss) .
Policy A pays nothing (as loss is fully paid by B)
Loss Property I $ 1000
All other propositions in example 1 remain the same.
Policy B pays first= $ 700 (being limit of sum A pays insured)
Policy A pays (1000/2000) X 300 (balance of loss) =$ 150
Insured bears $ 150/ $1000
From all these types of average it will be seen that it insurance is not property arranged on full value insurance, i. e., if there is under-insurance then the insured will not get full indemnity. But it has to be appreciated that this is due to defective arrangement of insurance for which principle of indemnity cannot be blamed. One point is to be remembered here which is this that if the benefit of average is to be obtained by insurers then they must put this average condition in the policy. Otherwise, even though there is under-insurance average cannot be applied.