Cedric Stephens | The average clause – fairness or punishment?

When Jamaicans buy property insurance, few pause to read the fine print. Yet, buried in almost every policy is a condition that can make the difference between financial survival and ruin after a disaster. It is called the average clause, or the pro-rata condition of average.
This clause says that if your property is underinsured, your claim will be reduced in proportion. Suppose the new replacement value of your house is $20 million, but you insure it for $10 million. If a hurricane causes $5 million in damage, you will not be paid $5 million. You will receive only half – that is, $2.5 million less the hurricane excess (or deductible or $200,000) – because the building was insured for only half its value. Catastrophe losses like hurricanes and earthquakes are usually subject to excesses or deductibles of two per cent of the sum insured.
Insurers argue that the average clause is fair. Consumers, on the other hand, often feel blindsided when the average clause is applied to claims. The debate over fairness has played out in courts, regulatory offices, and newspaper columns across the industrialised world. Jamaica, however, still applies the clause in its traditional form. Should we follow the Western trend of softening its impact?
Why insurers defend it
The rationale is simple: insurance premiums are calculated based on the value at risk. If people deliberately underinsure to save money, then expect full payouts, the system collapses. Honest buyers would end up subsidising the reckless.
Insurers see the clause as a safeguard against moral hazard, that is, people who are reckless or try to ‘beat the system’. It forces policyholders to declare accurate sums insured and keeps the premium pool equitable. In mathematical terms, it is a neat solution.
Why consumers dislike it
But in practice, most underinsurance is not deliberate. It happens because:
• Inflation pushes up construction costs faster than policyholders adjust their sums insured.
• Valuation errors occur when owners guess rather than commission professional appraisals.
• Complexity – many buyers simply do not understand the clause until their claim is cut.
• Poorly trained insurance and mortgage company employees – some of whom are paid sales commissions – do not explain important policy provisions like the average clause. Mortgagors are often not told that ‘mortgage insurance’ is intended to protect the interests of mortgagees.
The result is harsh. Families who have paid premiums faithfully over many years discover, at the worst possible moment, that their payout is slashed. To them, the clause feels less like fairness and more like punishment.
In Western industrialised societies, regulators, and courts have responded to consumer complaints.
• United Kingdom & the European Union: Regulators now insist that insurers explain the clause in plain language. Courts generally uphold it, but ombudsmen have pressured insurers to soften its application.
• United States: Some states limit how strictly the clause can be applied, especially if underinsurance was not intentional.
• Consumer watchdogs: Across Europe and North America, rulings have forced insurers to pay more generously when buyers were misled, or when inflation made sums insured outdated.
The trend is clear: the clause survives, but it is being tamed.
Industry innovations
Insurers themselves have introduced strategies to reduce the sting:
• Index-linked policies: Automatically adjust sums insured for inflation.
• ‘Day One’ reinstatement cover: Promises to pay the full rebuilding cost at current prices, not the outdated sum insured.
• Tolerance margins: Some insurers allow a 10–15 per cent margin of error before applying the clause.
• Waivers for small claims: In minor losses, insurers sometimes pay in full regardless of underinsurance.
These innovations show that insurers recognise the clause’s harshness and are trying to balance fairness with financial discipline.
The caribbean context
Here in Jamaica, the clause remains firmly in place. After hurricanes, many homeowners discover too late that their claims are reduced. Rising construction costs, currency fluctuations, limited access to professional valuations, and ignorance about hurricanes and earthquakes make underinsurance almost inevitable. On the other hand, health insurance companies are beginning to highlight the importance of wellness, while their general insurance counterparts and the regulator are silent on these hazards in the context of national resilience.
The existing 55-year old policy measures in relation to disclosures about average clause are clearly dysfunctional, according to information that I received from one industry source. They should be the subject of reform.
The fairness question
Insurers say the clause protects the system. Consumers say it punishes the innocent. Regulators abroad increasingly agree with the latter, pushing for transparency and softer application.
The Jamaican insurance industry faces a choice: cling to tradition or modernise in line with global best practices and the island’s cultural practices. For policyholders, the stakes are high. A clause that looks neat in actuarial textbooks can feel devastating in real life.
Conclusion
The average clause was designed in Western countries to keep insurance fair. But fairness in theory is not always fairness in practice. In those societies, regulators and insurers have recognised this and acted. Jamaica must now ask: do we continue to apply the clause in its strictest form, or do we reform it to protect ordinary buyers from unfair surprises? Insurance subject-matter expertise will be essential in designing appropriate solutions, as I argued last week.
The answer will determine whether insurance remains a trusted shield against disaster – or a trap hidden in the fine print.
Cedric E. Stephens provides independent information and counsel on insurance and risk management. To obtain assistance, write to the Business Editor at business@gleanerjm.com or contact Mr Stephens directly at aegisja@gmail.com Letters and emails will be edited for clarity and length.