The Co-Insurance Clause: What Every Building Owner Must Know

What is a co-insurance clause in commercial insurance?

A co-insurance clause can reduce a partial claim if your building is insured below the threshold in the policy. It is also called the average clause or the underinsurance clause.

The gap is common. MCG, a firm of quantity surveyors, found across its own valuations that buildings were about 24 per cent short on average. And as rebuild costs climb, a figure set years ago falls further behind.

How does the co-insurance clause work on a partial loss versus a total loss?

A figure that is too low can cost you on both kinds of loss. A partial claim pays only a share, and a total loss stops at the policy's limit.

Partial loss: the payout gets scaled down

If the average clause applies, take your sum insured, or on some policies the higher limit above it. Divide it by 80 per cent of what the property would cost to replace. That gives the share of a partial claim the insurer can pay. Multiply the loss by that share, and you have the most the claim pays.

Say your building would cost $1 million to rebuild today, and you have it insured for $500,000. On a policy that compares the sum insured itself with the 80 per cent, you needed to be insured for $800,000, and you carried $500,000. That is 62.5 per cent of the required amount, so the insurer can pay 62.5 per cent of a partial claim. A $100,000 roof replacement then pays $62,500 before the excess, and the missing $37,500 is yours to find, even though the loss was nowhere near your sum insured.

A published complaint decision shows the clause at work. A commercial building was insured for $300,000 against a quantity surveyor's value of about $568,000. A fire repair claim of about $35,000 was cut to about $23,000 under the average clause. The clause stood: the policy had explained it clearly, with a worked example. The decision still added 15 per cent to the settlement, because the repair quote was old.

Total loss: the policy pays up to its limit

If the same building burns down, most of the business packs we arrange pay up to 20 per cent above the amount you insured it for. That is up to $600,000 towards the $1 million rebuild. Whatever the rebuild costs beyond that is yours to fund.

Does the co-insurance clause apply to contents, fit-out and lost income too?

Usually, yes. Contents, stock and fit-out count in the same test as the building. Business interruption cover, which protects your profits while you rebuild, generally has its own test. A claim on it can be cut back if its figure is set too low.

In one published complaint decision, a Sydney salon's interruption cover was set as low as $150,000 against a true figure of more than $1.15 million, and the 80 per cent clause was upheld.

If you lease the building out, lost rent is paid only if a rent item is on your interruption cover, so check your schedule shows one. The rent item usually has its own 80 per cent test. The rent figure to insure is your current tenant's annual rent, excluding GST but including outgoings. It is worth a fresh look at each new tenant and rent review.

The test looks at everything at the premises, not just the building

Most of the business packs we arrange test the property insured under that policy at the address together. Your policy may settle claims on a reinstatement or replacement basis, paying to rebuild or replace what was lost. Where it does, the test compares the total you insured with 80 per cent of what it would all cost to replace.

Picture everything at the address: the building, the fit-out, contents, stock, plant and machinery, and electronic equipment. The owner's fixtures, fittings and plant within the building sit in the building figure on those policies. Contents covers what belongs to you or is your responsibility. Whether an item sits in the building figure, contents or stock, it counts in the total the clause tests.

Say your building figure is spot on but your contents or stock figure was set years ago. You are tested on the combined number, so a shortfall anywhere in it can scale down a claim on the part you got right. That is why the building, contents and stock figures on a commercial property policy are worth setting together.

If your stock swings through the year, a figure set in a quiet month can be short at the peak. The seasonal stock clause explains how a policy can allow for that.

How far short can your sum insured fall before the clause cuts a claim?

On some of the policies we place, your sum insured can fall 20 per cent short of the building's full value before the cut starts. Some run the test on a higher limit above your sum insured instead, so your figure can fall further. Which one applies changes what a short figure costs you at claim time.

Your policy wording may call that higher limit the limit of indemnity or the limit of liability, the most the policy pays for one event.

Most of the policies we arrange measure the building's value at the start of the policy year, so renewal is the time to set your figure.

What the two tests do to one claim

The $1 million building example uses the stricter of the two tests. It tests the $500,000 sum insured exactly as declared, which is why it lands on 62.5 per cent and a $62,500 payout on a $100,000 roof claim. Until you know which test yours runs, plan on the stricter one.

On a policy that tests the higher limit, the figure is $600,000 against the same $800,000 requirement. That is 75 per cent, so the same $100,000 claim pays $75,000 before the excess. The extra margin does not replace insuring for the full rebuilding cost.

When does the co-insurance clause not apply?

When the policy does not carry the clause in the first place. None of the commercial strata wordings we place carries a co-insurance or average clause; commercial strata insurance sets out how a scheme funds a shortfall instead.

On small claims. Most of our business packs do not cut a small loss. Small usually means under 10 per cent of your sum insured or of the policy's higher limit, depending on the policy. The full test applies to a serious loss.

On the extra cost of current building codes. The average clause does not scale that cost down on those packs, and the building sum insured guide explains how it is paid.

When the insurer did not tell you about it in writing first. An insurer can rely on an average clause only if it told you clearly in writing, before you took out the policy, about the clause and what it does. That notice usually sits in your policy document, often with a worked example.

What can your broker do if a claim is cut for underinsurance?

The figures used in the calculation can be wrong. For our clients, we read the policy wording and work out the reduction ourselves. We do not accept the insurer's or loss adjuster's calculation at face value. Where it is wrong, we take it up with the insurer. We have found errors this way repeatedly.

In a 2025 storm claim we handled, the clause cut the owner's payout, but working through the insurer's calculation with the wording still moved the settlement. How an underinsurance cut is worked out tells that claim in full.

How do you make the co-insurance clause irrelevant?

Insure your commercial building to a proper rebuild figure, and the clause has no shortfall to work on. That figure is today's cost to rebuild. It is often mistaken for what you paid, the council valuation or last year's number nudged up a few per cent.

On several of the wordings we place, the underinsurance penalty can be waived if the valuation and sum insured meet the policy's conditions.

A lower figure can look like a saving at renewal, and a tenant who pays the premium through the outgoings may ask for one. A lower figure can trigger the clause, leaving you to fund part of a repair bill.

Where your policy indexes your sum insured, it typically moves in line with a building-cost index, so it is only as good as the figure it started from.

Do you know your building's replacement cost? If your sum insured is short, you pay the shortfall when you rebuild. We commission a desktop building replacement estimate for you, free. We commission it for our purposes as your broker, to inform the advice we give you.

What happens next depends on what the estimate shows and what you want from it. If your figure looks right, we may simply say so. If the estimate and your own figure are close, we can quote you on both. Where we find a gap, a higher excess can help keep the higher figure affordable. If the full figure is hard to fund this year, we can talk about your next rent review. Whichever figure you choose is your call. You can read what the estimate is, and what it is not.

If you are not sure where your own figure stands, check your underinsurance risk in two minutes.

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