Insurance is a contract between the insurer and the insured, and as such it is subject to numerous terms and conditions as contained in the policy wording. Beyond this contract there are a number of accepted principles and practices that determine how the insurer should respond to the insured and vice versa.
In Part 1, we looked at the definition of Sum Insured and Replacement Value. In part 2, we will unpack the average clause and the capital additions extension.
An insurer is contracted to provide indemnity against the risk of loss or damage occurring. Sums insured are one of the most important factors in determining premium necessary to underwrite the relevant insurance risk in a sustainable manor. As such, if an insurance value is incorrect the calculation of premium required in relation to risk being covered may be incorrect. It is with this in mind that the insurers include other policy conditions such as average and capital additions.
Some people requiring insurance may provide inadequate sums insured unintentionally (due to ignorance of property value) or intentionally (as a way of reducing their premiums). The average clause is included in order to protect the insurer against such incidents and practices which cause an imbalance in the finances of the insurance policy. Premium is calculated against sum insured and without the correct premium being raised, it is highly unlikely that the insurer will be able to underwrite in a sustainable manner.
The average clause makes the insured a co-insurer (with the insurer) by placing responsibility on the insured for a portion of the damage or loss in an amount relative to the degree of error of their sum insured. Therefore, if the sum insured is found to be only 75% of the actual replacement value, the property is 25% under insured. As such, the insured becomes a co-insurer and the insurer will only pay 75% of the relevant claim.
Property Value: R100 000
Sum Insured: R60 000
Claim Amount: R30 000
Under Insurance: 40% (R100 000 – R60 000)
Insurer Pays: R18 000 (R30 000 x 60%)
Insured Pays: R12 000 (R30 000 x 40%)
While clauses such as average are intended to protect the insurer, many of the policy clauses and extensions such as capital additions are intended to protect the interests of the insured.
The capital additions clause allows for an extension of the sum insured by an additional 15% to accommodate the insured for any improvements that are made to the property which increase its replacement value during the period of insurance. In other words, where the insured improves or extends their property and does not notify the insurer to adjust the sum insured, capital additions allows for a safety cushion of 15% of the listed sum insured.
Author: Bruce Gibson
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