In simple lay man’s language- under insurance is declaration of value for insurance lower than its actual value by an Insured person. This is important because in case a property is insured for lower value, any loss occurring under the policy is reduced proportionately. So, if a factory worth ₹100 crores is insured for Rs. 70 crores, a claim under the policy shall be settled only to the extent of 70% (70/100) of the loss.
The rationale for this rule is both a matter of principle as well as of business practice. The basic insurance principle of utmost good faith requires both parties to the insurance contract to not conceal/ misrepresent any detail to which only they are privy to. In case of under-insurance it is obvious that this principle is not being complied with, may be deliberately by an Insured (to save premium cost). The practical business reason is -if the insurance business is to fulfill its purpose, it needs to be fair to all policy holders. It is expected to manage the premium pool created with contribution of all policy holders. Most of them having paid premium on their correct values. So, paying full claim to a person who has not contributed to the pool in full, is like stealing money from other policy holders who have been sincere and honest with the insurance company.
Before we go into the aspect of 15% under insurance benefit under the policy, we need to understand the background of IAR Policy and the reason for its introduction in the Indian market. before the introduction of IAR policy, it was frequently observed that the companies did not adequately opt for various insurance covers which would offer comprehensive protection in event of losses due to varied reasons. The cause of this ranged from ignorance to sheer lethargy. So, it was decided to offer a comprehensive product for small to mid-sized companies.
Since opting for more number of policies would involve payment of higher premium, a system of discount on opting for more than one cover as well as some extra benefits in the policies were offered as an incentive.
15% under insurance benefit is one of such sweeteners offered by Insurers. Basically it means that if the property worth Rs 100 crores is insured for ₹85 crores, the penalty of under-insurance shall not be levied on claims arising under this policy. However, if the insured value is say ₹80 crores, the loss is to be settled after applying the full penalty for under insurance.
The conscious decision to offer limited benefit (15% only) to the policy holder and not above it is to discourage misuse of the relaxation by under insurance of higher degree.