The principle of indemnity is such a principle of insurance stating that an insured may not be compensated by the insurance company in an amount exceeding the insured’s economic loss. An 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 is that the experience gets unfavorable leading to enhancement of the premium to 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. There are three types of average in practice. These are;
- 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.
- A 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. This condition is usually applied to those types of properties (e.g., stock) where there is a possibility of violent fluctuation in price rapidly.
- 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.