In our daily work as an insurance brokerage, clients often ask us about technical concepts we use frequently. Recently we discussed the rule of equity. Today we wanted to explain underinsurance and the proportional rule, because both are widely used terms in the insurance market.
Definition of Underinsurance
Underinsurance refers to a situation where the policy does not reflect the correct value of the insured object, valuing it below its real value. In the event of a claim, the insurer will apply the proportional rule, meaning that the indemnity is paid in proportion to the value of the risk that has been assumed.
How underinsurance and the proportional rule are applied in the event of a claim
The operation of insurance is simple: the price of the premium increases as the value of the insured object increases.
Example of Underinsurance
For example, if someone takes out home insurance with furniture worth EUR 10,000 but values it at EUR 5,000, they will save money on the premium. However, if a claim occurs, the indemnity will be proportional to that EUR 5,000 value and therefore much lower than the real value of the asset.
The probability of the claim occurring also comes into play, as this is something the insurer considers when setting the premium, or claims frequency. In the end, the corresponding indemnity will use the proportional rule between the value assigned to the object or objects and the risk of a claim.
What Is the Difference from the Rule of Equity?
The proportional rule should not be confused with the rule of equity.
Explanation of the Rule of Equity
The rule of equity reduces the indemnity due to an aggravation of risk. In other words, even if the asset was correctly valued, the risk circumstances were modified by the person taking out the insurance.
Example of the Rule of Equity
One example would be taking out shop insurance and stating that the premises have an alarm when, in reality, the shop has no alarm. The premium is lower because the risk appears lower. If the shop is then burgled and the insurer discovers the misstatement, the insurer may apply the rule of equity by reducing the benefit that would otherwise have corresponded.
Conclusion
In conclusion, while the proportional rule adjusts the indemnity due to differences in the value of the asset, the rule of equity does so because the risk has increased. In any case, underinsurance and the proportional rule are tools insurers use to control and fairly manage the premiums they agree with their clients.