What is the Average Clause in Workers' Compensation Insurance?

In workers’ compensation insurance, the Average Clause plays a key role in ensuring fairness for both the business and the insurer. This clause comes into play when there is a change in the number of employees or their average wages during the policy term.

Let us say, a company initially declares a certain number of workers and their income when purchasing the policy. But, over time, if more people are hired or wages increase, the actual workforce and income levels might be higher than what was reported.

The insurance company uses the Average Clause to adjust the sum insured, which is the maximum amount they will pay in the event of a claim. Therefore, if the number of employees or their earnings exceeds the originally declared amount, the insurer may reduce the payout proportionally. This is done to ensure that the coverage matches the real situation, avoiding overpayment or underpayment of claims.

Businesses need to understand this clause because it determines the amount of compensation they will receive in the event of an accident. Being upfront and regularly updating the insurer about changes in workforce or salaries can help avoid any unpleasant surprises during claims. This way, everyone gets fair protection.

While the Average Clause affects the insurer’s payout, it does not influence the statutory benefits that an injured employee is entitled to. These benefits, like medical expenses, disability compensation and lost wages, are determined by the Workmen’s Compensation Act or other relevant laws. The insurance policy simply provides the funds to cover these benefits.

So, in simple terms:

• The Average Clause ensures the insurer pays claims fairly, based on the actual workforce.
• Statutory benefits for the injured worker are fixed by law, regardless of the insurance payout adjustment.

By keeping track of your workforce size and wage changes and informing your insurer regularly, you can avoid surprises and ensure your workers are protected and your business is covered properly.

Also Read: Benefits of Workmen’s Compensation Insurance

The Average Clause in workers' compensation insurance is a critical provision that ensures fair claim settlements when discrepancies arise between declared and actual employee numbers or wages. Understanding the conditions under which this clause applies is essential for employers to maintain adequate coverage and avoid unexpected financial liabilities.

Under-Declaration of Employee Numbers

When a company purchases a workers' compensation policy, it declares the number of employees to be covered. If, at the time of a claim, the actual number of employees exceeds the declared number, the Average Clause comes into effect. In such cases, the insurer adjusts the claim amount proportionally, covering only the ratio of declared employees to actual employees.

For instance, if a policy covers 80 employees, but the company has 100 employees at the time of an incident, the insurer will cover 80% of the claim amount. The remaining 20% becomes the employer's responsibility.

Under-Declaration of Wages

Similarly, if the wages declared in the policy are lower than the actual wages paid at the time of an accident, the Average Clause is triggered. The insurer will compare the declared wages with the actual wages and adjust the claim payout accordingly.

So, suppose if the policy declares ₹10,00,000 in wages, but the actual wages paid are ₹15,00,000, the insurer will cover only two-thirds of the claim amount, leaving the employer to cover the remaining one-third.

Changes in Workforce During Policy Term

The Average Clause also applies when there are fluctuations in the workforce during the policy period. Suppose employees join or leave the company, and these changes are not communicated to the insurer. In such cases, discrepancies can arise between the declared and actual employee numbers or wages, resulting in adjusted claim settlements.

The calculation under the Average Clause is straightforward. The formula is:

Claim Payable = (Declared Value / Actual Value) × Loss Amount

Where:

• Declared Value: The number of employees or total wages declared in the policy.

• Actual Value: The actual number of employees or total wages at the time of the claim.

• Loss Amount: The total claim amount before adjustment.

Here is an example to help you understand how the Average Clause works in workers' compensation insurance:

Sunrise Manufacturing Pvt. Ltd. is a mid-sized company specialising in textile production. When the company purchased a workers' compensation insurance policy, they declared 80 employees with an estimated wage roll of ₹50,00,000. Based on this, the insurer calculated the premium and issued the policy.

However, during the policy period, the company expanded its operations and hired additional workers to meet the growing demand, increasing its workforce to 100 employees. Unfortunately, the company did not inform the insurer about this increase.

A few months later, an incident occurred at the factory. One of the workers, Ramesh, suffered a severe injury while operating a machine, resulting in a claim under the workers’ compensation policy. The total loss amount, including medical expenses and disability benefits, came to ₹1,00,000.

When Sunrise Manufacturing submitted the claim, the insurer applied the Average Clause because the declared workforce was lower than the actual workforce. Using the formula:

Claim Payable = (Declared Employees / Actual Employees) × Loss Amount

Claim Payable = (80 / 100) × ₹1,00,000 = ₹80,000

In this scenario, the insurer will pay ₹80,000 towards Ramesh’s claim. The remaining ₹20,000 will have to be covered by Sunrise Manufacturing Pvt. Ltd. out of its pocket.

This example illustrates how under-declaring employee numbers can result in reduced claim payouts. Regular updates and accurate declarations are crucial to ensure fair and complete protection for both the business and its employees.

Also Read: Workers’ Compensation Insurance Premium Estimation

The Average Clause plays a vital role in ensuring fairness and balance in workers' compensation insurance. It benefits both the insurer and the insured in several important ways.

Fair Premium Calculation

Insurance premiums are calculated based on the actual risk a business presents. If an employer under-declares the number of employees or their wages, they end up paying a lower premium than they should. This clause ensures that the premiums accurately reflect the business's real risk exposure, making the system fair for all parties.

Preventing Underinsurance

The Average Clause encourages employers to declare accurate payroll figures and operational details. Without it, businesses might be tempted to under-report wages or the size of their workforce to save on premiums. This could result in insufficient coverage, leaving the company vulnerable during claims.

Ensuring Insurer Stability

Insurance companies depend on fair premium collection to maintain their reserves and meet claim obligations. If many businesses underreport, the insurer's financial stability could be at risk. The Average Clause helps maintain the system's robustness and reliability for all policyholders.

Supporting Risk Management

Accurate payroll and classification data allow insurers to assess and manage their risk portfolios more effectively. This ensures that risks are fairly distributed and that coverage remains sustainable.

By now, we have seen how the Average Clause plays a critical role in ensuring fair payouts in workers’ compensation insurance. But beyond this technical detail, the bigger picture is about why having a solid Workers’ Compensation plan is not just a good idea, but an absolute necessity for businesses operating in India.

Here are a few reasons why you need one:

Law Mandates It

Under the Employee’s Compensation Act, 1923 (earlier known as the Workmen’s Compensation Act), employers are legally obligated to compensate employees for any injury or illness they suffer in the course of employment. This law applies to a wide range of employees.

Failure to comply does not just risk penalties. It could also mean the employer is personally liable for paying compensation. For any business, especially small to medium-sized enterprises (SMEs), this could result in severe financial strain.

Protect Your Business Financially

Workplace accidents and occupational diseases are not just unfortunate. They can be extremely expensive. Costs can include medical bills, wage replacement, disability compensation and even death benefits for dependents.

Without a Workers’ Compensation policy, your business could bear these costs directly, putting its financial health at risk. With a policy in place, these expenses are covered, ensuring your business stays protected.

Prioritising Employee Welfare

When a business invests in Workers’ Compensation insurance, it sends a clear message: we care about our people. This builds trust and morale. Knowing they are protected in the event of a work-related injury gives employees peace of mind, allows them to focus on their recovery, and boosts overall productivity.

Also Read: Types of Workers’ Compensation Insurance

Understanding the Average Clause in workmen compensation insurance is crucial for every business. For businesses, especially small and medium-sized enterprises (SMEs), this is not just a legal requirement; it is a safety net that protects both the company and its employees.

TATA AIG offers a reliable Workers Comp Insurance plan that covers unexpected expenses and provides financial protection for your workforce. Alongside this, our SME Insurance Policy solutions help businesses of all sizes manage risks and stay prepared for the future.

Make the smart choice today and ensure your business stays protected while you focus on growth with the right workmen's compensation plan.

• How can employers accurately assess their workforce size and payroll to avoid underinsurance and the impact of the Average Clause?

Employers should maintain accurate records of their workforce size and total payroll. Regular payroll audits and consultations with HR or finance teams can help ensure the declared figures match the actual numbers.

It is also wise to review employment contracts and wages periodically, especially after new hires, role changes, or pay revisions. Keeping your insurance provider informed of these changes helps maintain proper coverage and avoids complications from the Average Clause.

• How often should employers review and update their payroll and workforce data to avoid issues with the Average Clause?

Employers should review payroll and workforce data at least once a year. However, it is even better to review whenever there are major changes, such as expansion, new projects or restructuring.

Keeping an eye on seasonal changes, like hiring temporary staff, is also essential. Always communicate these updates to your insurance provider to ensure your workers' compensation policy reflects the actual situation, helping you avoid claim reductions due to the Average Clause.

• Can employers avoid the Average Clause’s impact by over-declaring the workforce size or payroll?

Over-declaring workforce size or payroll might sound like a simple solution, but it can actually lead to higher premiums without providing any real benefit. Insurers expect accurate and honest data.

Overestimating to increase claim potential can violate policy terms and may lead to claim disputes or even denial. The best approach is to accurately and genuinely declare your workforce size and payroll, ensuring coverage aligns with your business’s actual needs.