What are the average clause and the tolerance rule in insurance?
What are the average clause and the tolerance rule in insurance?
When you take out insurance, it is essential that you declare the correct value of the insured assets and all the relevant risk circumstances. However, what happens when there is a discrepancy between what was declared and the reality? This is where two fundamental legal mechanisms come into play: the average clause in insurance and the tolerance rule in insurance.
Both rules are contained in Spanish insurance legislation and have a direct impact on the compensation you will receive in the event of an accident or loss.
Understanding these rules is essential. In this article, we delve into what these are, when they apply, how they work and why it is so important to declare the correct values in your insurance contract.
What is the average clause?
The average clause in insurance is a legal mechanism that proportionally reduces the compensation paid out when the insured value is lower than the actual value of the insured item. This clause is governed by article 12 of Law 50/1989 on Insurance Contracts and it aims to ensure a balance between the premium paid and the actual risk covered.
The average clause applies in the event of the following circumstances:
- The insurance holder has declared a value of the insured asset that is lower than its actual value at the time of the accident or loss.
- This undervaluation was not deliberate and was not made in bad faith by the insured party.
- In the event of an accident or loss, the insurer finds a difference between the declared value and the actual value.
In SegurCaixa Adeslas home insurance policies, there are two cases where underinsurance does not apply when the insured sums are lower than the insured assets:
When the capital recommended by the company was insured, even if it is less than the actual value of the assets.
When this difference is less than 15%.
When the accident or loss entails a cost that is less than that indicated in the particular conditions for non-application: €4,500 in SegurCaixa Full Home, SegurCaixa Premium Home and MyBox Home, or €2,500 in SegurCaixa Home
Mathematical equation
To calculate the compensation paid out when the average clause is applied, insurers use the following mathematical equation:
Compensation = (Insured sum / Actual value of the asset) × Damage amount
This equation means that the compensation will be proportionally reduced in the same proportion as between the asset’s declared value and its actual value.
Practical example
Let’s imagine you have a home insurance policy and you have insured the contents of your home for 30,000 euros. However, when there is a fire, the insurer finds that the actual value of the insured item (the entire contents of the home) is actually 60,000 euros.
If the fire caused damage in the amount of 20,000 euros, the compensation will be calculated as follows:
- Insured value: €30,000
- Actual value: €60,000
- Actual damage: €20,000
- Compensation = (30,000 / 60,000) × 20,000 = €10,000
As you can see, even though the actual damage amounts to 20,000 euros, you will only receive 10,000 euros of compensation because the insured sum only represents 50% of the actual value. The compensation has been proportionally reduced in the same proportion.
There is another concept known as the principle of indemnity: If one of the items is overinsured, this can compensate for the “excess” premium of the other item if it is underinsured.
This principle can also be applied to car insurance, where declaring the incorrect value of the vehicle can result in a proportionally lower compensation payout in the event of a total loss.
What is the tolerance rule?
The tolerance rule in insurance is a principle that adjusts the compensation paid out when the premium paid does not accurately reflect the actual risk, as a result of incomplete information or changes that were not declared in the questionnaire or insurance simulation.
It applies, for example, if:
- The home has undeclared special materials or construction (e.g., wood).
- The insured square meterage is less than the actual area.
- There are other risk conditions not correctly reflected in the initial declaration.
In these cases, the insurer proportionally reduces the compensation to compensate for the difference between the premium paid and the premium that would be correct according to the actual risk, ensuring that the coverage and the payment are proportional to the risk assumed.
Practical example
Let’s imagine that you insure your home, stating that it is 120 m² and of standard construction, but the insurer discovers that in reality it is 150 m² and part of the home is built with wood. The premium that you paid was lower than what the actual risk would entail.
If the damages amount to €50,000, the insurer will apply the tolerance rule and adjust the compensation in proportion to the difference in risk. This enables you to:
- Avoid excessive penalties for unintentional mistakes.
- Ensure that the compensation reflects the actual risk assumed.
Comparison: average clause against tolerance rule
Even though both clauses relate to the correct valuation of the insured assets, there are fundamental differences between the average clause in insurance and the tolerance rule in insurance. Grasping these differences is essential to understanding how your policy will work in the event of a loss or accident.
- Application threshold: The most important difference lies in the undervaluation percentage. The tolerance rule in insurance applies when the difference between the insured value and the actual value is no higher than 10% (or the percentage established in the policy’s actual conditions). The average clause automatically applies when it is above this threshold.
- Impact on compensation: Under the tolerance rule, the insured party receives full compensation for the damage suffered, with no reduction of any kind, as long as it does not exceed the insured sum. However, when the average clause applies, the compensation is reduced proportionally according to the mathematical equation shown above, when can entail a significant financial loss to the insured party.
- Insured party protection: The tolerance rule acts as a protection measure for insured parties acting in good faith that have made small valuation errors or whose assets have slightly changed in value. The average clause, on the other hand, is a direct consequence of more significant undervaluations, with a strict mathematical adjustment applied.
When are these rules applied?
It is neither the insured party nor the insurer who decides on which clause applies. Instead, this is defined according to the objective criteria established in Law 50/1989 on Insurance Contracts:
- Tolerance rule: This is automatically used when the undervaluation is less than 10%, when the insured party has not acted in bad faith and when they have complied with their duty of good faith by taking out a policy.
- Average clause: This applies with the undervaluation exceeds 10% of the actual value of the asset, provided the insured party has not acted in bad faith. If there is aggravation of risk or deliberate bad faith, the consequences may be even more serious, with the insurer potentially refusing to pay out compensation.
In both cases, the actual value of the item is determined at the time of the accident or loss, not when the policy is taken out. This means that the insured parties must regularly update the insured sums to reflect the market reality and the actual condition of their assets.
Although the law establishes these mechanisms, article 12 specifies that the parties may agree to rule out or amend the application of these rules. However, in practice, standard contracts for individuals retain these legal criteria with no significant modifications.
These rules work in the same way for both home insurance and car insurance. What matters is the proportional difference between the declared value and the actual value, regardless of the type of asset insured.
Importance of these clauses for the insured party
Understanding the average clause in insurance and the tolerance rule in insurance is essential for many reasons that have a direct impact on your financial protection:
- It avoids unexpected financial loss. Knowing these clauses enables you to understand that a significant undervaluation can lead to a compensation payout that is much lower than the actual damage suffered.
- It encourages accurate and up-to-date declarations. Knowing that the average clause exists motivates insured parties to declare realistic values and to regularly check the insured sums.
- It protects insured parties acting in good faith. The tolerance rule in insurance recognises that small mistakes or minor changes in the valuation are normal and should not seriously penalise those who act honestly.
- It guarantees contractual balance. These clauses ensure that there is proportionality between the premium paid and the risk covered. If you pay a premium calculated on 30,000 euros, but the actual risk is 60,000 euros, it is unfair to expect full coverage.
- It prevents fraud and bad faith. By establishing clear consequences for significant undervaluations, these clauses dissuade fraudulent acts such as trying to pay lower premiums by declaring incorrectly low values.
- It facilitates conflict resolution. Having objective and mathematical criteria established by law (such as the mathematical equation of the average clause) reduces disputes between insured parties and insurers in the event of an accident or loss.
- It makes it possible to make informed decisions. Knowing these clauses helps you to assess whether the insured sums in your policy are adequate and whether you need to adjust them.
- It minimises unpleasant surprises. Many insured parties discover these clauses only when they suffer an accident or loss and receive a compensation payout that is lower than expected. Knowing about these in advance enables you to act preventatively, adjusting the insured sums.
FAQs
What is underinsurance?
Underinsurance occurs when the insured value is lower than the actual value of the asset at the time of the accident or loss. It is this state that activates the application of the average clause in insurance or the tolerance rule in insurance, depending on the degree of undervaluation.
Underinsurance can occur for different reasons: an initial incorrect valuation when taking out a policy, not updating the insured sums over time, improvements made to the property that increase its value, inflation that increased the cost of replacement, or simply not knowing the true market value of the assets.
To avoid underinsurance, it is essential that you make realistic, professional valuations of your assets, annually review the insured sums and update them as necessary, consider all the elements that comprise the total value (e.g., in homes: structure, installations, contents and improvements), and seek advice from professionals or assessors when you are unsure about the actual value.
Does the average clause always apply?
No, the average clause does not apply in every case of undervaluation. There are several scenarios when it will not apply:
- When the tolerance rule applies.
- When the parties rule it out: according to article 12 of Law 50/1989 on Insurance Contracts, the parties can mutually agree to rule out the application of this clause in the contract.
- Agreed value insurance: in some insurance policies, particularly for old vehicles or works of art, the parties decide on an “agreed value” from the outset. In these cases, that agreed value is what will be paid out without applying the average clause, irrespective of the actual market value at the time of the accident or loss.
- When the party has acted in bad faith.
- Minor partial accidents or losses. In some contracts, for very small losses, the insurers may opt not to apply the average clause for practical reasons and for customer relations, although technically they could do so.
Can I avoid the average clause being applied?
Yes, there are several strategies for avoiding the average clause in your insurance contract being applied:
- Declare correct, realistic values: The most effective way of avoiding the average clause is to insure your assets for their actual value.
- Regularly update the insured sums: Review your policy annually and update the insured sums to reflect changes in the value of the assets.
- Take out insurance policies with a replacement value: Some insurance policies, especially for home insurance, offer a “rebuild value” option, where the insurer undertakes to replace the asset for a new equivalent, regardless of the age or depreciation.
- Negotiate special clauses: In high-value policies or business insurance policies, you can negotiate the inclusion of clauses that rule out or limit the application of the average clause with the insurer.
- Take out insurance at an agreed value: For certain assets such as classic cars, works of art or jewellery, consider taking out policies where the value of the asset is agreed in advance. In these cases, that agreed value is what will be paid out with no argument as to the actual value and no application of the average clause.
- Stay within the tolerance margin: Make sure your valuations are accurate enough so that any minor deviation from the actual value falls within the 10% margin, thereby activating the tolerance rule in insurance instead of the average clause.
- Document the value of the assets: Keep invoices, valuations, photographs and any documentation that supports the declared value. This demonstrates your good faith and can help you negotiate with the insurer in the event of an accident or loss, especially if there are discrepancies as to the actual value of the asset.