What is the significance of the 'average clause' in property insurance?

The 'average clause' in property insurance is a crucial component that addresses the issue of underinsurance. Its primary significance lies in how it adjusts claims payouts if the insured property is not fully covered according to its value. When a property is underinsured, the average clause effectively reduces the amount of any claim. This means that the insurer will only indemnify the policyholder for a proportion of the loss that reflects the ratio of the actual coverage to the full value of the property at risk.

For example, if a property is valued at $100,000 but insured for only $70,000, in the event of a loss, the insurer would pay only 70% of the claim amount, since the property was insured for less than its actual value. This mechanism encourages policyholders to adequately insure their property to avoid such deductions in claim payments.

The other options do not align with the functions of the average clause. It does not prevent claims from being paid out or ensure full compensation regardless of the insured value. Additionally, while premiums can be influenced by property values, the average clause itself does not directly increase them based on these values; rather, it functions at the claims payment stage.