The Small Print That Makes a Big Difference: Understanding the Average Clause
If you are a Managing Agent, RTM Company, Freeholder or Landlord responsible for insuring a commercial or mixed-use building, there is one clause in your policy that could catch you out at the worst possible moment: it's called the average clause.
It rarely gets much attention until a claim is underway and by then, it's often too late to do anything about it. Here's what it means, why it matters, and how to make sure it doesn't cost you.
What Is the Average Clause?
The average clause (sometimes called "condition of average") is a standard provision in most commercial property policies. It's designed to penalise underinsurance.
In simple terms: if the sum insured on the policy is lower than the true rebuild or reinstatement cost of your property, the insurer will only pay out a proportion of any claim even if the claim itself is far smaller than the total sum insured.
How It Works in Practice
The calculation typically looks like this:
Claim payout = (Sum Insured ÷ Actual Rebuild Cost) × Claim Amount
For example, imagine a building has a true rebuild cost of £2,000,000, but it's only insured for £1,500,000 — that's 75% of its real value. If a fire causes £200,000 worth of damage, the insurer won't pay the full £200,000. Instead, they'll apply the same 75% ratio, meaning the payout would be reduced to £150,000.
The policyholder is left to cover the remaining £50,000 themselves obviously a significant, unexpected shortfall, especially when the original underinsurance may not have been intentional at all.
Why Underinsurance Happens So Easily
Underinsurance is rarely a case of cutting corners. In our experience, it usually comes down to:
- Outdated valuations: rebuild costs are reassessed infrequently, while construction and materials costs rise steadily year on year.
- Confusing market value with rebuild cost: a property's market value and the cost to rebuild it from scratch are two very different figures, and using the wrong one is a common and costly mistake.
- Building improvements or extensions: works carried out since the last valuation that haven't been reflected in the sum insured.
- Inflation and rising construction costs: even a policy that was accurately valued two or three years ago may now be significantly out of date.
Why This Matters More for Real Estate Professionals
For Managing Agents, RTM Companies, Freeholders and Landlords, the stakes are particularly high. A shortfall following a major claim doesn't just affect one party, it can mean:
- Leaseholders or tenants facing unexpected costs via service charge demands
- Disputes between freeholders, RTM companies and residents over responsibility for the gap
- Delays to reinstatement works while funding is resolved
- Reputational damage for the managing agent or freeholder responsible for arranging cover
Given these consequences, getting the sum insured right isn't just good practice, it's a core part of responsible risk management.
How to Avoid Being Caught Out
The good news is that the average clause is entirely avoidable with the right approach:
1. Obtain a professional reinstatement valuation. Valuations provide an accurate, defensible rebuild figure, distinct from a market value estimate.
2. Review the sum insured annually. Even without major building works, construction costs shift year on year, so cover should be reassessed regularly to keep pace.
3. Reassess after any building works. Extensions, upgrades or structural changes should prompt an immediate review of the sum insured.
4. Keep valuations independent and up to date. Relying on figures from several years ago, or on general market estimates, is one of the most common causes of underinsurance.
Key Takeaway
The average clause exists to keep insurance fair for everyone, but it only works in a policyholder's favour if the sum insured reflects the true cost of rebuilding. For those managing residential and commercial buildings on behalf of others, an accurate valuation isn't just a matter of compliance, it's central to protecting the people who rely on that cover being right.
Disclaimer: The information provided in this article is for general informational and educational purposes only and does not constitute formal finance, legal or regulated insurance advice. Insurance coverage is subject to specific policy terms, conditions and exclusions and underwrite appetites.
