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Financial Accounting · Insurance Claim for Loss of Stock and Loss of Profit

Average Clause in Fire Insurance: Insurance Claims Basics

Updated 10 October 2026 · Fact-checked

An insurance claim for fire loss pays you the actual loss, never more than the sum insured. The average clause applies when the sum insured is less than the value of stock at the date of fire. Claim = Loss × Sum insured ÷ Value of stock at fire, limited to the sum insured.

Understand Insurance Claims Basics and Average Clause

A fire insurance policy is a contract of indemnity. It puts you back in the position you were in before the loss. It does not let you make a profit from the loss. So the insurer pays the actual loss suffered, subject to the policy limit.

The sum insured is the maximum amount the insurer will pay under the policy. It is a ceiling, not a promise to pay that amount. If your loss is ₹3,00,000 and the sum insured is ₹10,00,000, you get ₹3,00,000 at most. If your loss is ₹12,00,000 and the sum insured is ₹10,00,000, you get ₹10,00,000 at most.

That is the difference between the two terms. Indemnity is the principle: pay the actual loss only. Sum insured is the limit: pay no more than this amount.

Now the average clause. The premium you pay depends on the sum insured. If you insure stock worth ₹10,00,000 for only ₹6,00,000, you pay a lower premium but expect the insurer to cover your loss. The average clause stops this. It says that if the policy is underinsured, you bear part of the loss yourself. The insurer pays only the proportion that the sum insured bears to the value of stock at the date of fire.

The clause applies only when the policy contains it, and only when the sum insured is less than the value of stock at the date of fire. If the sum insured equals or exceeds that value, there is no averaging and the claim is the actual loss, limited to the sum insured. Note that the value used is the value at the date of fire, not the value at the date the policy was taken.

Key rules to remember

Indemnity rule
Claim ≤ Actual loss, and Claim ≤ Sum insured
The claim is the lower of the two when no average clause applies.
Claim under average clause
Claim = Net loss × Sum insured ÷ Value of stock at date of fire
Use only if the policy has the clause and Sum insured < Value of stock at fire.
Net loss of stock
Net loss = Stock at date of fire − Stock salvaged (salvage at its value)
Compute stock at fire first from the last trading account and the period's transactions.
Insured proportion
Proportion insured = Sum insured ÷ Value of stock at date of fire
The uninsured part is borne by the policyholder.

How to solve Insurance Claims Basics and Average Clause questions

Use the same sequence for any basic claim question. Do the stock calculation first, then apply the policy terms.

  1. 1Read the policy details: sum insured, whether the average clause applies, and the date of fire.
  2. 2Find the value of stock at the date of fire. If it is not given, prepare a memorandum trading account up to the date of fire.
  3. 3Deduct the stock saved (salvage) to get the loss of stock.
  4. 4Remove any amount not covered, if the question says so, to get the net loss.
  5. 5Compare the sum insured with the value of stock at fire. If it is equal or higher, there is no averaging.
  6. 6If it is lower and the clause applies, multiply the net loss by Sum insured ÷ Stock at fire.
  7. 7Check the result against the sum insured. The claim cannot exceed it.
  8. 8State the claim amount clearly and, if asked, the loss borne by the business.

Quickest way: Fraction shortcut for the average clause

When to use it: Use when stock at fire, loss and sum insured are all given in the question.

  1. Write the fraction Sum insured ÷ Stock at fire and reduce it, for example 6,00,000 ÷ 10,00,000 = 3/5.
  2. If the fraction is 1 or more, stop. Claim is the loss, capped at the sum insured.
  3. Otherwise multiply the net loss by the fraction.
  4. Quickly check: the claim must be less than the net loss and less than the sum insured.
  5. Write the formula line first, as it carries method marks.

Common mistakes in Insurance Claims Basics and Average Clause

  • Applying the average clause when the sum insured is equal to or more than stock at fire.

    Students apply the formula mechanically without comparing the two values.

    Fix: Always compare first. Average applies only if the sum insured is lower than stock at fire.

  • Using the stock value at the date of policy or the last balance sheet instead of the date of fire.

    The balance sheet figure is the only stock figure given.

    Fix: Use the value at the date of fire. Compute it through a memorandum trading account if needed.

  • Applying the proportion to the gross loss before deducting salvage.

    Students rush to the formula.

    Fix: Deduct salvage first, then apply the fraction to the net loss.

  • Claiming more than the sum insured.

    Students forget that the sum insured is a ceiling.

    Fix: After calculating, compare with the sum insured and take the lower.

  • Confusing indemnity with sum insured.

    Both words relate to the amount recoverable.

    Fix: Remember: indemnity is the principle of paying actual loss only; sum insured is the upper limit.

Worked examples

Example 1

Stock of Kaveri Traders on the date of fire was valued at ₹8,00,000. Stock worth ₹1,00,000 was salvaged. The sum insured was ₹5,00,000 and the policy has an average clause. Calculate the claim.

Show the solution
  1. Loss of stock = 8,00,000 − 1,00,000 = ₹7,00,000.
  2. Sum insured ₹5,00,000 is less than stock at fire ₹8,00,000, so the average clause applies.
  3. Claim = 7,00,000 × 5,00,000 ÷ 8,00,000.
  4. Claim = 7,00,000 × 5/8 = ₹4,37,500.
  5. Check: ₹4,37,500 is below the sum insured ₹5,00,000.

Answer: Claim = ₹4,37,500. The business bears ₹2,62,500 of the loss.

Example 2

Stock of Mehta Stores at the date of fire was ₹6,00,000. Stock saved was ₹1,50,000. The sum insured was ₹7,00,000 with an average clause. Calculate the claim.

Show the solution
  1. Loss of stock = 6,00,000 − 1,50,000 = ₹4,50,000.
  2. Sum insured ₹7,00,000 is more than stock at fire ₹6,00,000, so there is no underinsurance.
  3. The average clause does not reduce the claim.
  4. Claim = actual loss ₹4,50,000, which is within the sum insured.

Answer: Claim = ₹4,50,000. No reduction under the average clause.

Exam tips

  • In the written answer, show the comparison of sum insured and stock at fire. It earns marks even if arithmetic slips.
  • For MCQs, check first whether the sum insured is lower than stock at fire. Many options are traps that apply average wrongly.
  • Always deduct salvage before applying the fraction, unless the question says otherwise.
  • Write the formula before substituting numbers, and finish with a clear one-line claim statement.
  • If stock at fire is not given, expect to compute it from a memorandum trading account. Study that topic alongside this one.

Practice questions from Insurance Claim for Loss of Stock and Loss of Profit

Insurance Claims Basics and Average Clause: frequently asked questions

What is the average clause in fire insurance?

It is a policy condition that reduces the claim when the sum insured is lower than the value of stock at the date of fire. The insurer pays only the proportion Sum insured ÷ Stock at fire of the loss.

What is the difference between indemnity and sum insured?

Indemnity is the principle that the insurer pays only the actual loss. Sum insured is the maximum amount payable under the policy. The claim is limited by both.

Does the average clause always apply?

No. It applies only if the policy contains it and the sum insured is less than the value of stock at the date of fire. Otherwise the claim is the actual loss, capped at the sum insured.

How do I calculate a claim under the average clause?

Find the net loss after salvage, then multiply it by Sum insured ÷ Stock at fire. Check that the answer does not exceed the sum insured.