A Glossary of Claim Settlement Terms

Key things to know

1. A settlement letter sets out the payout, any deductions and the insurer’s reasoning; check it against your policy schedule before you accept it.
2. Depreciation reduces a payout to an item’s second-hand value; the cost of a comparable replacement minus depreciation is often called actual cash value.
3. The average clause allows a proportionate reduction if the sum insured is below the rebuild cost, so insuring to market value can leave claims short.
4. Betterment deductions apply where a repair improves the property, and you can ask the insurer to justify the amount withheld.
5. The Financial Ombudsman Service, set up by Parliament in 2001, is a free, informal way to challenge an unfair settlement once the insurer has had a chance to respond.

When an insurer decides a claim, the settlement letter that follows brings its own vocabulary. Terms such as cash settlement, depreciation, betterment and proportionate reduction appear with little explanation, yet each one affects the figure at the bottom of the page. This glossary takes them one at a time. For the language used earlier in the process, our glossary of insurance claim terms to know before you file covers the ground from notification onwards.

Why Settlement Letters Use Their Own Language

Settlement documents are written by claims teams who work in shorthand. The terms below recur in nearly every offer, and they repay attention before you read one.

• Settlement letter. The written offer setting out how the insurer proposes to resolve the claim, including the amount, any deductions and the reasoning behind them. Treat it as a document to check rather than a bill to pay.
• Indemnity. The principle behind most home and motor policies: a payment should return you to the position you were in immediately before the loss, no more and no less. Depreciation and betterment both follow from this idea.

Cash Settlement vs Repair or Replacement

Insurers usually have a choice about how they settle. Most wordings allow repair, replacement, reinstatement or a cash payment, and the insurer may pick between them.

• Cash settlement. A payment of money instead of a repair or a replacement item. It can suit you if you want to arrange your own contractor, but the sum should reflect what a reasonable repair or replacement would actually cost.
• Reinstatement. Restoring damaged property to its former state, usually by rebuilding. On buildings claims it is the standard the payout is measured against.
• Like-for-like replacement. Substituting an item or material of the same kind and standard as the one lost. If a policy promises this, a settlement that would only buy something clearly inferior is worth querying in writing.

Depreciation and Deductions for Wear and Tear

• Depreciation. A reduction that accounts for how old or worn the claimed item was, so you are paid its second-hand value instead of the price of a brand-new one. If the letter does not explain the figure, ask how it was calculated.
• Actual cash value. Settlement at what the property was worth when the loss happened: what a comparable replacement would cost, less an allowance for depreciation. You fund the difference if you want a brand-new item.
• Wear and tear. Ordinary deterioration through use, which policies commonly exclude rather than cover. Rejections on these grounds are often disputed, particularly where the item was relatively new or the damage was sudden.
• Co-payment. A fixed share of each claim that you pay yourself, on top of any excess. Some pet policies use them, and the Financial Ombudsman Service sees complaints where deductions for excesses, co-payments or policy limits have been applied unfairly.

Check your policy: A valid claim should be paid unless the insurer can point to a policy condition or exclusion that applies, and that includes being able to explain any deduction. If a settlement letter lists a figure you cannot follow, ask for the calculation in writing.

Proportionate Reduction: The ‘Average’ Clause

This is the deduction with the biggest financial consequences, and the one most people meet for the first time in a settlement letter.

• Proportionate reduction. A cut to the payout that matches how underinsured you were. If the sum insured covers half of the true rebuilding cost, the insurer may pay half of the claim and you fund the rest.
• Average clause. The policy term that allows this reduction. It exists to encourage accurate sums insured, so that people who underinsure do not get the same protection as those who pay a premium based on the full value.
• Sum insured. The ceiling on what can be paid for a claim. For buildings policies, this figure ought to match the cost of rebuilding rather than the price the property would fetch on the market.
• Rebuild cost. What it would cost to demolish your home and build it again on the same site. This can differ sharply from market value, which is why market price is a poor guide to a buildings sum insured.
• Underinsurance. Cover that is set too low to rebuild the property or replace everything in it after a serious loss. Many households discover the gap only when a claim comes in short; our article on why underinsured claims payouts fall short explains how that happens.

Betterment and Improvements

Repair work can occasionally leave a property better than it was, and the way insurers respond is governed by one main term.

• Betterment. An improvement that arises out of the repair, for example a higher-specification roof fitted because the original tiles are no longer made. Because a claim should not leave you better off, the insurer may deduct the value of that improvement, though you can ask it to justify the amount, particularly where the improvement was unavoidable because matching materials no longer exist.

Interim Payments and Final Settlement

Some settlement letters mention payments made along the way, and it helps to know what they commit you to.

• Interim payment. Money the insurer hands over while the claim remains open, commonly because the full extent of the damage or its final cost has yet to be established. Taking it does not end the claim.
• Final settlement. The agreed amount that closes the claim completely. Once accepted, the insurer’s liability for that claim normally ends, so check every figure and every deduction before you agree.
• Policy excess. The first part of the loss that you contribute, deducted from the settlement. Both compulsory and voluntary excess come off the payout however the rest of the claim is settled.

Reservation of Rights and Ex Gratia Payments

Two terms that appear on settlement letters describe payments that are not quite what they seem.

• Reservation of rights. A statement that the insurer is handling, or even paying, a claim while keeping its position open on whether the policy covers it. It is not an admission of cover and usually signals an investigation that is still running.
• Ex gratia payment. Money the insurer pays while stating that it does not accept the claim falls within the policy. The payment is a gesture of goodwill rather than a contractual settlement, and the wording can matter if the claim is disputed later.

Who to Ask When the Wording Is Unclear

Start with the claims handler, and put the question in writing so you have a record of the answer. You are entitled to know which policy term each deduction rests on. If the insurer will not explain, the Financial Ombudsman Service is a free service set up by Parliament in 2001 that investigates complaints about insurers and other financial businesses. It is an informal alternative to the courts, and if it finds a customer was treated unfairly it can use legal powers to put things right. It expects you to give the insurer the chance to respond first, and complaints about deductions, exclusions and claim handling fall within its remit. If the dispute is about a rejection rather than a payout figure, our guide to challenging a rejected insurance claim sets out the next steps, and our explainer on loss adjusters and loss assessors clarifies who works for whom when an expert is involved.

Read your settlement letter alongside the policy schedule, list every deduction you cannot follow, and ask your insurer to explain each one in writing before you accept the offer.

Questions answered

What does a cash settlement actually cover?
It is money paid instead of a repair or a replacement item, and the sum should reflect what a reasonable repair or replacement would cost. You can then arrange the work yourself.

Why has my payout been reduced under the average clause?
The clause applies when the sum insured is less than the full rebuild cost of the property. The insurer reduces the payout by the same proportion as the shortfall, leaving you to fund the difference.

Can the insurer deduct depreciation from my claim?
Policies that settle at actual cash value subtract an allowance for wear and use before paying. If the letter does not explain the figure, ask the insurer to show how it was calculated.

Who can help if I do not understand my settlement offer?
Ask the claims handler to explain each term and deduction in writing first. If the insurer will not clarify, the Financial Ombudsman Service is a free service that investigates complaints about insurers.