If an insured party is underinsured, which factor typically affects the compensation they receive?

When an insured party is underinsured, the compensation they receive is primarily influenced by the principle of average. This principle is a rule in insurance that ensures policyholders insure their assets at an adequate value relative to the actual value or replacement cost of the asset.

If the insured amount is less than the value of the asset, any claim made will be reduced in proportion to the level of underinsurance. For example, if a property is worth £100,000 and the insured amount is only £70,000, the principle of average may result in the insured party only receiving 70% of any claim, reflecting their level of coverage relative to the asset's total value. This principle is intended to discourage underinsurance and promote adequate coverage by ensuring that claims are settled in accordance with the proportion of coverage purchased.

In contrast, while the level of liability coverage, the replacement value, and the historical cost of the asset are important factors in insurance, they do not directly determine the compensation in the event of underinsurance. Liability coverage relates to the extent of coverage for legal liabilities, replacement value concerns the cost to replace an asset, and historical cost pertains to what the asset was originally purchased for. These factors may impact overall insurance valuation but do not directly address