Pro Rata Condition of Average
The term "pro rata" is used to describe a proportionate distribution, often involving a partial or incomplete status of payment due. For instance, pro rata can be used in bankruptcy claims, where an insolventdebtor's assets are divided proportionately among creditors based on the size of claims.
In the insurance industry, pro rata means that claims are only paid out in proportion to the insurance interest in the asset; this is also known as the first condition of average.
The pro rata condition of average can also be thought of this way: The insurer is only liable for the proportion of the loss that the amount of insurance under the policy bears to the actual cash value of the asset; the insured assumes all liability beyond that point.
How Pro Rata Works
Typically pro rata means that each person or in some cases party is given their fair share of something in relation to the whole.
In terms of annual interest, giving out the correct portion of an annual interest rate can be calculated using a time frame via pro rata.
Calculations for pro rata can be used to determine dividend payments, premiums on insurance, or similar situations where an amount is owed or due.
Key Takeaways
- Pro rata condition of average relates to the proportion of an asset that an insurance policy covers.
- A claim will only be paid out on an asset based on the insurable interest that the policy covers, so a 50% covered asset will only be paid up to 50% of its value as per the insurance policy.
- Most policies with pro rata conditionality are accompanied by a second, special condition of average.
- Pro rata condition of average is commonly used by property insurance companies whose policies cover damages.
Example of Pro Rata Condition of Average
Suppose that a homeowner takes out $200,000 worth of fire insurance on his home. The home is actually valued at $300,000. A fire subsequently breaks out in the home, causing $60,000 worth of damage to the interiors and exteriors of the property.
If the fire insurance policy uses the pro rata condition of average, the insurance company is only liable in proportion to the level of insurance relative to the value of the property. Since the insurance only covers two-thirds the value of the property ($200,000 / $300,000), the insured can only recover two-thirds the cost of damage—$40,000, in this case ($40,000 / $60,000). This can be unfortunate if the owner cannot afford to support the remaining cost of damages.
Special Considerations
Most insurance literature identifies only two separate conditions of average. The first is pro rata, as described above. The second is known as a special condition of average, whereby under-insurance is not penalized unless the sum represents less than 75% of the at-risk value. Most policies with pro rata conditionality are buttressed with a special condition.
FAQs
Pro rata condition of average relates to the proportion of an asset that an insurance policy covers. A claim will only be paid out on an asset based on the insurable interest that the policy covers, so a 50% covered asset will only be paid up to 50% of its value as per the insurance policy.
How to calculate pro rata insurance claim? ›
Pro Rata for Insurance Premiums
2 To do this, divide the total premium by the number of days in a standard term, and multiply by the number of days covered by the truncated policy.
What is the pro rata clause in insurance? ›
PRO RATA CLAUSE – A clause in an insurance contract providing that losses will be paid in the proportion that the amount of the contract bears to the entire amount of insurance covering the loss.
What is the average clause answer? ›
The average clause in insurance is a provision that applies when your property is undervalued or underinsured at the time of policy purchase. It affects the claim settlement in case of a partial loss due to fire. A partial loss is when your property is not destroyed by fire but only partially damaged.
What is the rule of average in insurance? ›
The average clause is a way of insurers paying out less than they need to if a policyholder is paying less than the premium they should be because they have inadequate cover. Insurers apply the average clause and only payout a proportionate amount for what you are claiming based on how much you are underinsured by.
What is pro rata average condition in insurance? ›
Pro rata condition of average relates to the proportion of an asset that an insurance policy covers. A claim will only be paid out on an asset based on the insurable interest that the policy covers, so a 50% covered asset will only be paid up to 50% of its value as per the insurance policy.
What is the pro rata formula? ›
Apply the pro rata formula: Plug the identified values into the formula: Pro Rata Share = (Individual Share / Total Shares) x Total Amount.
How do you calculate pro rata clause? ›
Pro rata is a calculation that determines the fair distribution of a fixed amount. These calculations are common for issuing dividends and determining part-time salaries. You can calculate pro rata by determining the payee's portion and multiplying it by the total fixed amount.
What is pro rata compensation? ›
Pro-rata is the proportional value of a part compared to its whole. A pro-rata salary is when employers pay their employees for the number of hours they worked in proportion to what they would earn if they worked full-time.
What is the average clause under the insurance formula? ›
A3: Under the average clause, policyholders agree to maintain a specific percentage of insurance coverage based on the property's actual value. If a fire causes partial loss or damage, the claim payout is determined by the formula: Claim Amount = (Insurance Carried / Insurance Required) x Loss.
Condition of average (also called underinsurance in the U.S., or principle of average, subject to average, or pro rata condition of average in Commonwealth countries) is the insurance term used when calculating a payout against a claim where the policy undervalues the sum insured.
How do you work out the average clause? ›
Basic + Loadings - Deductions What is the formula for calculating average clause? Sum insured for / True value X Loss Explain average clause. Average clause states that if the insured individual insures an item for a percentage of its value, then they will only receive that percentage in compensation.
What is the 80% average clause? ›
The 80% rule means that an insurer will only fully cover the cost of damage to a house if the owner has purchased insurance coverage equal to at least 80% of the house's total replacement value.
What is the 80% rule in insurance? ›
When it comes to insuring your home, the 80% rule is an important guideline to keep in mind. This rule suggests you should insure your home for at least 80% of its total replacement cost to avoid penalties for being underinsured.
What is an example of the principle of average in insurance? ›
Average clauses appear in insurance policies of all types of asset. So, for example, you are insuring your house and you tell the insurer its value, which forms the sum insured under the policy. The premium is based on the declared value and will be lower than what it should be if the true value was given.
How do you calculate a pro rata bill? ›
Here's how to calculate prorated charges they owe:
- Take the monthly rate and divide it by 30 to get the amount per day.
- Multiply the rate per day by the number of days to get the prorated sum.
Calculating prorated bonuses is relatively straightforward. To do so, you need to divide the number of months, weeks or days the employee worked by 12, 52 or 365, respectively, then multiply the answer by the total bonus amount you would've paid for a full year's work.
What is the formula for calculating insurance claims? ›
The actual amount of claim is determined by the formula:
Claim = Loss Suffered x Insured Value/Total Cost. The object of such an Average Clause is to limit the liability of the Insurance Company. Both the insurer and the insured then bear the loss in proportion to the covered and uncovered sum.
How do you calculate insurance claim ratio? ›
(Total number of claims settled in a year/ Total number of claims in a year) X 100 = Claim Settlement Ratio (CSR). For example, out of the 10,000 claims filed in 2019-2020, Company A settled 9,600 of them. As a result, its CSR will be 96% (9,600/10,000*100) for that year.
