AFCA Decision Highlights Impact of Averaging Provisions on Claim Payouts

A recent AFCA determination underscores the significant consequences of underinsurance clauses reinforcing the importance of accurate property valuations in business insurance policies. 

The Australian Financial Complaints Authority (AFCA) has ruled in favour of an insurer after an underinsurance clause significantly reduced the value of their claim payout. 

Underinsurance clauses or averaging provisions (also known as averaging provisions) enable insurers to reduce their liability if the insured property is found to be underinsured. Where the sum insured is less than the true value of the property, the claim payment is reduced in proportion to the level of underinsurance.

This provision ensures that policyholders share in the financial consequences of underinsurance, reflecting their contribution to the risk. 

The complainant, who held a business insurance policy with the insurer, sought full compensation for damages amounting to $295,455.05 after a driver being pursued by police collided with the insured property. 

The property was insured for $452,000, significantly below its Full Insurable Value of $1,864,646.01. Under the policy’s underinsurance clause, the insurer was only required to cover a proportion of the damage, in this case, the policy required the insurer to cover 30.3% of the damage, amounting to $89,522.88. Despite this, the insurer offered $104,038.16 – more than what the policy required – due to an earlier miscalculation in the complainant's favour. 

AFCA concluded that the insurer was entitled to apply the underinsurance clause, as the complainant did not provide any reason why it should not apply. The determination emphasised that the complainant agreed the property was underinsured and did not dispute the insurer’s valuation of the Full Insurable Value. 

Underinsurance clauses are common in many business insurance policies. Under the Insurance Contracts Act may only rely on such clauses if insurer clearly informed the insured in writing of the nature and effect of the provision prior to entering into the contract. This is usually done through the Product Disclosure Statement (PDS). 

However, PDSs are often lengthy and complex, and policyholders frequently overlook them. Without the guidance of an insurance broker, policyholders may not fully understand that an underinsurance clause applies or how it could impact a claim payout.  

For brokers, the ruling serves as a reminder of the importance of thorough risk assessments and clear communication with clients about the implications of underinsurance, including the potential for reduced payouts in the event of a claim. By proactively addressing underinsurance risks, brokers can help clients avoid unexpected financial shortfalls and disputes. 

There is growing scrutiny on how underinsurance clauses are communicated to policyholders.  Most recently, the Inquiry into insurers’ responses to 2022 major floods claims recommended that insurance brokers and insurers be required to provide clear guidance on the operation of averaging provisions to small and medium sized businesses and that the government should also consider prohibiting averaging provisions for small businesses.