Although the scenario illustrated above shows the importance of obtaining full coverage of an asset at the outset, businesses must also bear in mind that the Average Clause dictates that the sum insured is always adjusted to reflect the present total value at risk.
How inflation ‘activates’ the Average Clause
Inflation changes the total value at risk of an asset, which means that a fully insured asset at the start of the policy period can become partially insured after a period of time and hence subject to the Average Clause.
In an inflationary environment, while companies may feel that having a lower sum insured/partially insuring an asset can help them save costs, the potential financial consequences arising from the Average Clause can far outweigh any initial benefits.
Take Korea for instance, where the cost for chemical manufacturing machinery and parts increased by 27% in the span of a year (see chart below) while the cost of semiconductor manufacturing machinery increased by 2% in the same period: