A textile mill in Bhiwandi. Insured for ₹8 crores. Fire damages the premises to the extent of ₹4 crores. The owner expects the claim to be settled for ₹4 crores. The insurer pays ₹2 crores.

What happened? The mill was actually worth ₹16 crores double what it was insured for. Under the average clause, the insurer pays claims in the same proportion as the cover bears to the actual value. Half-insured means half-paid, regardless of the size of the loss.

This is underinsurance. It’s more common than most business owners realise, and it’s one of the costliest mistakes you can make with an insurance policy.

Why Underinsurance Is So Widespread

The short answer is that policies get renewed without being reviewed. A factory that was worth ₹5 crores when it was first insured in 2018 may be worth ₹9 crores today because construction costs have risen, equipment has been upgraded, and the value of stock has grown. But if the sum insured has stayed at ₹5 crores through successive renewals, the policy is now dangerously inadequate.

Construction costs in India have risen significantly in recent years, driven by material costs, labour, and inflation. A building that cost ₹2,000 per square foot to construct a decade ago may cost ₹3,500 to rebuild today. If your property policy reflects the original cost, you’re not fully covered.

The same applies to stock, plant, and machinery. Many businesses carry stock that fluctuates seasonally but insure for an average value that doesn’t reflect peak levels. A loss during the festive season when stock is at its highest can result in a claim that significantly exceeds the insured amount.

Understanding the Average Clause

The average clause is the mechanism insurers use to deal with underinsurance, and it’s built into most standard fire and property policies in India. The formula is simple: the claim settlement is reduced proportionally to the degree of underinsurance.

If your property is worth ₹10 crores and you’ve insured it for ₹6 crores, you’re 60% insured. If you suffer a loss of ₹3 crores, the insurer pays 60% of that ₹1.8 crores not the full ₹3 crores. The remaining ₹1.2 crores comes out of your own pocket, regardless of how genuine and legitimate your claim is.

Most policyholders only discover the average clause exists when they’re sitting across from a surveyor after a loss. That’s not the right time to learn about it.

Getting the Sum Insured Right

The correct sum insured for a property is its reinstatement value what it would cost to rebuild or replace the asset at current prices, not what you originally paid for it.

For a building, this means calculating the cost of reconstruction per square foot at current market rates, including professional fees, debris removal, and compliance costs. For machinery and equipment, it means the replacement cost of equivalent modern equipment. For stock, it should reflect peak stock levels, not average ones.

This isn’t a one-time exercise. As construction costs rise and your business grows, the reinstatement value increases. Annual review of your sum insured at renewal isn’t bureaucracy it’s the only way to ensure your policy stays adequate.

Business Interruption: The Loss Beyond the Loss

Underinsurance isn’t limited to property damage cover. Loss of Profit or business interruption policies are equally vulnerable to being set at inadequate levels.

If your factory is shut down for four months following a fire, your loss isn’t just the cost of repairs. You’re also losing revenue, paying fixed costs salaries, loan repayments, rent without the income to cover them. Loss of Profit insurance covers that period of financial exposure.

But if the indemnity period is too short, or the sum insured doesn’t reflect your actual annual profit and standing charges, the policy won’t pay what the business needs to survive the interruption. We see this regularly businesses that buy Loss of Profit cover but underestimate the indemnity period because they’re optimistic about recovery timelines.

What a Property Insurance Review Should Cover

A proper property insurance review goes through every asset category buildings, contents, plant, machinery, stock, and business interruption and validates that the sums insured reflect current reinstatement values. It identifies any average clause exposure and recommends corrections before a loss occurs.

It should also check that the policy is correctly structured for your risk that flood, earthquake, or machinery breakdown perils are included where relevant, and that the insurer is one who will perform reliably at claim time.

This is the conversation we have with every new property insurance client at MPG, and the review we carry out for existing clients when market conditions or business circumstances change.