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NISM-Series-X-B: Investment Adviser (Level 2) · Non-Life Insurance Products

Home and Property Insurance: Fire Policies and Average Clause

Updated 11 October 2026 · Fact-checked

Home and property insurance is a non-life indemnity cover for loss or damage to a building and its contents from named perils such as fire, lightning, flood and burglary. If the sum insured is below the property's value, the average clause cuts the claim in proportion. Claim = loss × sum insured ÷ value.

Understand Home and Property Insurance

Home and property insurance is a non-life contract. It pays for physical loss or damage to property. It follows the principle of indemnity: you are put back in the position you were in before the loss, not into a better one. You must also have an insurable interest in the property, as owner, tenant or lender.

In India the base product is the Standard Fire and Special Perils (SFSP) policy. It covers named perils. The standard fire perils are fire, lightning, explosion or implosion, and similar. The special perils add items such as storm, cyclone, flood, inundation, impact damage, riot and strike, subsidence and landslide, and bursting of pipes. Exact lists depend on the policy wording, so read the question for what it names. Perils not named are not covered. Wear and tear, war and nuclear risks are standard exclusions.

Householder and home policies package cover into two parts. Building cover protects the structure: walls, roof, fixtures and fittings fixed to it. Contents cover protects movable items such as furniture, appliances, clothing and valuables. Many packages also add burglary and theft, and some add personal accident or liability. You can buy building only, contents only, or both. A tenant has no insurable interest in the building but can insure contents.

Valuation decides the sum insured. For a building, the usual basis is reinstatement value: the cost to rebuild it, excluding land value. Market value includes land and location premium, so it is not the right base. Contents are often insured on market value, which is replacement cost less depreciation. Reinstatement or new-for-old cover on contents is available if chosen, and then you pay a higher premium.

Underinsurance happens when the sum insured is less than the true value. The average clause then applies. The insurer treats you as your own insurer for the shortfall and pays only a proportion of the loss. This is why correct valuation matters. Overinsurance does not help: you cannot recover more than the actual loss.

Key formulas to remember

Average clause
Claim = Loss × Sum insured ÷ Value of property at the time of loss
Applies only when the sum insured is less than the value. The claim never exceeds the sum insured.
Underinsurance test
Sum insured < Value of property → average applies
If the sum insured is equal to or above the value, the full loss is paid, up to the sum insured.
Building valuation basis
Sum insured (building) = Reinstatement cost, excluding land
Land is not damaged by fire, so exclude its value.
Indemnity limit
Payout ≤ lower of actual loss and sum insured
You cannot profit from a claim. Any excess or deductible is further subtracted as per the policy.

How to solve Home and Property Insurance questions

Use this order for any question on home or property insurance.

  1. 1Identify what is insured: building, contents, or both. Treat each item separately if separate sums are given.
  2. 2Check the peril. Is it named in the policy, such as fire, flood or burglary? If not named or excluded, the claim is nil.
  3. 3Check insurable interest and the principle at work: indemnity, proximate cause, utmost good faith.
  4. 4Find the value of the property at the time of loss on the correct basis: reinstatement for building, market value for contents unless stated.
  5. 5Compare the sum insured with the value. If lower, apply the average clause.
  6. 6Compute the claim as loss × sum insured ÷ value. Cap it at the sum insured.
  7. 7Subtract any deductible or excess if the question states one, then pick the option.

Quickest way: Ratio check for average

When to use it: Use it for any numerical question that gives a sum insured, a value and a loss.

  1. Write the ratio sum insured ÷ value as a fraction, such as 60 ÷ 100 = 60%.
  2. If the ratio is 1 or more, answer with the full loss, capped at the sum insured.
  3. If the ratio is below 1, multiply the loss by the ratio.
  4. Check that the answer is lower than the loss. If not, redo it.
  5. Look for the trap options: full loss, sum insured, and loss × value ÷ sum insured.

Common mistakes in Home and Property Insurance

  • Using market value including land to value the building.

    Students think the property price is the right base.

    Fix: Use reinstatement cost of the structure only. Land is not lost in a fire.

  • Applying the average clause when the sum insured equals or exceeds the value.

    Students apply the formula mechanically.

    Fix: Check first. Average applies only on underinsurance.

  • Inverting the ratio and getting a claim higher than the loss.

    Confusion about which number is on top.

    Fix: Sum insured goes on top. The claim must be less than the loss under average.

  • Assuming all perils are covered under a home policy.

    The word 'comprehensive' suggests everything.

    Fix: Cover is for named perils only. Exclusions such as wear and tear, war and nuclear risks stay out.

  • Thinking overinsurance earns a larger claim.

    Students link a higher sum insured to a higher payout.

    Fix: Indemnity limits the claim to the actual loss. Extra sum insured only costs more premium.

  • Treating building and contents as one sum insured.

    The package is sold together.

    Fix: Apply the sum insured and the average clause to each item separately, unless the question says otherwise.

Worked examples

Example 1

A house is insured under a fire policy for a building sum insured of ₹40,00,000. Its reinstatement value at the time of loss is ₹60,00,000. A fire causes a loss of ₹12,00,000. Assuming the average clause applies and there is no deductible, how much is payable?

Show the solution
  1. Sum insured = ₹40,00,000. Value = ₹60,00,000.
  2. Sum insured is lower than value, so the property is underinsured and average applies.
  3. Ratio = 40,00,000 ÷ 60,00,000 = 2/3.
  4. Claim = 12,00,000 × 2/3 = ₹8,00,000.
  5. Check: ₹8,00,000 is below the loss and below the sum insured.

Answer: ₹8,00,000

Example 2

A tenant insures household contents for ₹5,00,000. Market value of the contents at the time of loss is ₹4,00,000. Burglary, a covered peril, causes a loss of ₹1,50,000. What is the claim?

Show the solution
  1. Sum insured = ₹5,00,000. Value = ₹4,00,000.
  2. Sum insured is above the value, so the property is not underinsured.
  3. The average clause does not apply.
  4. Claim = actual loss = ₹1,50,000, which is within the sum insured.
  5. The extra ₹1,00,000 of cover gives no extra payout, because of indemnity.

Answer: ₹1,50,000

Exam tips

  • Expect numerical questions on the average clause. Practise the ratio until it is automatic.
  • Read the peril carefully. Questions often hide an excluded cause such as wear and tear or war.
  • Remember that building valuation excludes land, a favourite trap.
  • Link the topic to indemnity, insurable interest and proximate cause in questions that ask which principle applies.
  • Negative marking is 25% of the question's marks, so skip a question only if you cannot narrow to two options.

Practice questions from Non-Life Insurance Products

Home and Property Insurance: frequently asked questions

What is the difference between building and contents cover?

Building cover protects the structure and fixed fittings. Contents cover protects movable items such as furniture, appliances and clothing. You can buy either or both, and a tenant can insure contents only.

What is the average clause in fire insurance?

It applies when the sum insured is less than the value of the property at the time of loss. The insurer pays loss × sum insured ÷ value. It makes you bear the shortfall in proportion.

What does the Standard Fire and Special Perils policy cover?

It covers loss or damage from named perils. These include fire, lightning and explosion, plus special perils such as storm, flood, impact, riot and strike. Perils not named and standard exclusions are not covered.

Which value is used to insure a building?

The usual basis is reinstatement value, the cost of rebuilding the structure. Land value is excluded, because land is not destroyed by fire.