Insurance Australia Group (IAG) New Zealand and the Commerce Commission have reached a $3.48m compensation settlement agreement over potential violation of the Fair Trading Act to over 150,000 insurance policies.

The underwriter had revealed a glitch in August 2011, while assessing Canterbury earthquake claims and informed the Commission in October 2011.

According to the firm, the problem affected some house and contents insurance policies offered by NZI, Lantern, ASB, BNZ and Co-operative Bank.

IAG undervalued the sum insured in 643 previously paid out total loss insurance claims due to the problem, while the same error is now expected to affect the renewal of 150,755 current policies, says the regulator.

It was discovered that in some cases the policies affected dated back to 1980, and include a sum insured which was to be automatically adjusted each year to reflect rising inflation.

Due to this fault, the underwriter wrongly set the sum insured adjustments, which was below the rate of inflation for much of that period resulting in lesser calculation of sum insured than actual for some people.

Under the settlement plan, compensation will be given to affected customers who have previously been paid out on total loss insurance claims, and those with total loss claims, to reflect what they should have received, or are due to receive.

IAG will also offer the more than 150,755 current policyholders the option of either accepting an increased sum insured amount and therefore a higher insurance premium or agreeing a different value, in addition to reimburse the Commission’s costs.

Commerce Commission General Manager Competition Kate Morrison said IAG’s error was administrative, but had potentially far-reaching effect, particularly for people at their most vulnerable, following significant personal loss.

"Through its proactive response IAG has avoided a potentially lengthy and costly investigation and affected customers have been, or will be, compensated," Morrison added.

IAG New Zealand is a wholly-owned subsidiary of IAG, and operates under the brand names of State and NZI as well as distributing insurance through intermediaries.