What does the average clause in a property insurance policy do?

• A. It increases payout if underinsured
• B. It allows policy cancellation
• C. It limits liability if sum insured is less than value
• D. It ensures the policyholder receives the full reinstatement value

Answer: (C)

The average clause works to ensure the insurer only pays a proportional share of a loss when you’ve underinsured. If the property’s actual value is higher than what you’ve insured for, the payout is reduced in the same proportion as the sum insured is to the actual value.

Example: if the property is worth 500,000 but you insure it for 350,000 and you suffer a loss of 100,000, the insurer would pay 350,000/500,000 × 100,000 = 70,000. You’d cover the remaining 30,000 yourself.

This mechanism discourages underinsurance and makes the payout depend on how properly you’ve valued and insured the property. It does not increase the payout for underinsurance, nor does it guarantee full reinstatement value or permit easy cancellation.