The Average Clause Explained: Singapore Underinsurance Penalties on Partial Losses

Q: The Average Clause Explained: Singapore Underinsurance Penalties on Partial Losses

The average clause (sometimes called the "condition of average" or "co-insurance clause") is a standard provision in most Singapore non-life commercial insurance policies that reduces the insurer's payment on a partial loss in proportion to the under-insurance ratio. If the sum insured at the time of loss is 70% of the actual value of the insured property, a partial-loss payment is reduced to 70% of what it would otherwise have been. The principle is codified for marine insurance in section 81 of the Marine Insurance Act 1906 and applies as a matter of standard wording across most non-marine property, contents, stock, plant-and-machinery, business interruption, and group medical covers in Singapore. The clause does not apply to a total loss - a total loss pays up to the sum insured regardless of any under-insurance - but for the more common partial-loss scenarios the clause is operative. This article sets out the mechanics, the calculation, the SME implications, and the renewal-time question that determines whether the SME's cover responds as expected.

The Answer in 60 Seconds

The average clause (sometimes called the "condition of average" or "co-insurance clause") is a standard provision in most Singapore non-life commercial insurance policies that reduces the insurer's payment on a partial loss in proportion to the under-insurance ratio. If the sum insured at the time of loss is 70% of the actual value of the insured property, a partial-loss payment is reduced to 70% of what it would otherwise have been. The principle is codified for marine insurance in section 81 of the Marine Insurance Act 1906 and applies as a matter of standard wording across most non-marine property, contents, stock, plant-and-machinery, business interruption, and group medical covers in Singapore. The clause does not apply to a total loss - a total loss pays up to the sum insured regardless of any under-insurance - but for the more common partial-loss scenarios the clause is operative. This article sets out the mechanics, the calculation, the SME implications, and the renewal-time question that determines whether the SME's cover responds as expected.

The Sourced Detail

The average clause is the structural reason that under-insurance is more expensive than the premium saving. The clause is so standard in Singapore commercial insurance practice that its presence is generally assumed; the variations are in the formula (pro rata, special, or two-condition average) and in the exemption thresholds applied.

The principle

The average clause expresses a simple principle: if the SME has insured for less than the actual value of the property, the SME is treated as self-insuring the under-insured portion. At a partial loss, the SME bears the under-insured proportion; the insurer bears the rest, up to the sum insured.

The principle is fair from an insurance-pooling perspective: the SME paid premium on a lower value than the insurer was actually at risk for, so the insurer's share of any loss is proportionate to the share of risk that was paid for.

The standard pro-rata average formula

The standard pro-rata average clause operates as:

Insurer pays = (Loss amount) × (Sum insured / Actual value at time of loss)

Capped at the sum insured (in the case of total loss).

A worked example. An SME has property with an actual value of S$1 million. The SME insures for S$700,000 (70% of value). A partial loss of S$300,000 occurs.

Under standard pro-rata average:

Insurer pays = S$300,000 × (S$700,000 / S$1,000,000) = S$300,000 × 0.70 = S$210,000

The SME bears S$90,000 of the loss out-of-pocket, plus any deductible.

Why the average clause exists

The economic logic of the average clause is to prevent SMEs from systematically under-insuring. Without the clause, an SME could insure for a small fraction of the actual value and still recover the full partial-loss amount up to the (lower) sum insured. Insurers would respond by raising base rates to reflect the over-payment risk, and the cost would be borne by SMEs who insured to value.

The average clause aligns the SME's incentive (insure to value to avoid the penalty) with the insurer's pricing assumption (rate against full value).

Where the average clause applies

The average clause is standard in the following Singapore commercial covers:

Fire and property (building, contents, stock, plant and machinery).
All-risks property.
Business interruption (against the gross profit basis).
Group medical (in some structures, where the sum insured per employee is below typical claim amounts).
Group personal accident (similar to group medical structure).

The clause is not typically operative on:

Liability covers (PL, PI, D&O, cyber, EPL) - the sum insured is a maximum limit, not a declared value of a finite asset.
WICA - the statutory schedule applies regardless of premium.
Motor third-party - the statutory minimum applies.

For BI specifically, the average clause operates against the gross profit basis. If the SME's actual annual gross profit was S$2 million but the BI cover was set against a declared S$1.5 million, a partial-period BI loss is reduced to 75% of what it would otherwise have been.

The "special average" formula

Some Singapore property wordings carry a "special" or "85% average" formula. Under this variant, the average clause applies only if the under-insurance exceeds a stated threshold (commonly 15%, so the SME is permitted to under-insure up to 85% of actual value without the clause biting).

The special average is typically narrower for the SME than the pro-rata average. SMEs should check which formula their policy uses.

The "first loss" exception

A "first loss" basis explicitly contracts out of the average clause for a specified peril or limit. Common applications:

Theft of stock in a property policy may be on a "first loss" basis up to a stated limit.
Money cover is typically "first loss" up to the sub-limit.

The "first loss" provision allows the SME to insure for a portion of the value without average penalty for the specified peril.

How to avoid the average clause penalty

Three operational approaches.

Approach 1: Insure to value, refreshed regularly. The sums insured are reviewed at every renewal against current values. The average clause does not bite if the sum insured equals the actual value.

Approach 2: Build a margin into the sum insured. Some insurers permit (or recommend) declaring a 10-20% margin above current value to accommodate mid-year value increases. The margin functions as a buffer against minor under-insurance.

Approach 3: Negotiate a "first loss" basis for specific perils where insuring to full value is not commercially reasonable.

The first approach is the standard. The second is operationally easier. The third is reserved for specific situations where the cover economics support it.

The valuation question

The average clause operates against the actual value at the time of loss. The valuation method matters:

Reinstatement - the cost to rebuild or replace as new. Typically higher than current market value.
Replacement - the cost to acquire equivalent functionality. Similar to reinstatement for fungible assets.
Indemnity value (market value) - the value of the asset in its current state, accounting for depreciation.

The policy's valuation basis is the standard against which the average clause measures. An SME insured on a reinstatement basis should declare reinstatement values, not market values.

The post-loss adjustment

At claim time, the insurer's loss adjuster typically determines whether the average clause applies and at what ratio. The SME may dispute the adjuster's valuation (and is entitled to its own valuation) but the cover-response runs against the disputed valuation in the meantime.

A pre-loss valuation - particularly for high-value or specialty items - is a useful defensive measure. The valuation report sits in the policy folder.

Common Mistakes / What Goes Wrong

Rolling forward last year's sum insured without revaluation. Most common cause of average-clause exposure.
Confusing market value with reinstatement value. Insurance basis is typically reinstatement.
Insuring building structure without contents revaluation. Stock and equipment typically grow faster than building structure.
BI cover with stale gross-profit basis. The actual gross profit has moved.
Group medical with insufficient per-employee sum insured. Average applies at the per-employee level if structured that way.
No documentation of the valuation basis. Difficult to defend the sum insured at claim.
Assuming average does not apply. It typically does, unless contracted out.
Not checking the special-average formula. A 15% buffer may or may not be in the wording.
First-loss provision not understood. Specific perils may carry a different mechanic.
No pre-loss valuation for high-value items.

What This Means for Your Business

Review sums insured against actual values at every renewal.
Use the correct valuation basis per the policy.
Maintain a current asset register with replacement values.
For BI, refresh the gross-profit basis annually.
Document the valuation methodology in the policy folder.
Build a margin above current value where the wording permits.
Consider pre-loss valuations for high-value or specialty items.
Run the 60-minute audit to flag any under-insurance.

Questions to Ask Your Adviser

For each of our property and BI covers, what is the average clause formula (pro-rata, special, or other)?
For our current sums insured, how do they compare to current values - is there any under-insurance exposure?
For high-value items, what pre-loss valuation would you recommend?
For BI, is the gross-profit basis current, and what is the buffer?
Where could a "first loss" basis be negotiated for specific perils that are not commercially insurable to full value?

Related Information

Published 22 May 2026. Source verified 22 May 2026. COVA is an introducer under MAS Notice FAA-N02. We do not recommend insurance products. We provide factual information sourced from primary regulators and route you to a licensed IFA who can match a policy to your specific situation.