How does the average clause function in property insurance?

The average clause functions in property insurance by ensuring that the insured property is appropriately covered relative to its full value. When a property is insured for less than its actual value, this clause comes into play to reduce the payout in the event of a claim. The primary reason for this is to encourage policyholders to insure their property for its full value, thereby preventing underinsurance and the associated risks.

If a property is underinsured at the time of a loss, the average clause calculates the amount of the claim payout based on the proportion of coverage to the actual value of the property. For example, if a property valued at $100,000 is insured for $70,000, then in the event of a loss, the insurance payout would be reduced according to that ratio. This mechanism discourages policyholders from taking the risk of insuring for less than the full value, ensuring they bear a part of the loss due to their choice of insufficient coverage.

The other options presented do not accurately reflect how the average clause operates. There is no flat payout involved, the clause does not increase payouts for overinsured properties, nor does it guarantee full coverage regardless of the property’s value. Instead, it serves as a correction mechanism to uphold the principle of indemn