The sum insured in property insurance
The Sum Insured
The sum insured is the insurers maximum liability, and is the basis upon which the premium is calculated. It represents the maximum value at risk of property. It is the proposer’s responsibility to determine the sum insured which should represent the full value of the property covered. The sum insured is neither an admission by the insurers of the value of the property nor is it the amount the which the insurer promises to pay in the event of losses unless this is provided in the contract of insurance.
Premium is the price charged by the insurer for the risk undertaken. Essentially, the insurer should receive a premium commensurate with the risk assumed. The sum for which the subject matter is insured should represent its full value throughout the period of insurance cover.
In case the sum insured is less than full value of the property, there is said to be under insurance. This in effect means that the insured is paying a premium which is inadequate into the common pool, out of which all losses are paid. In other words, the premium they are paying does not reflect the risk they have brought into the pool.
The insured however, still expects the insurer to pay 100% of any loss from the accounts yet their contribution is less that 100 of the full premium. This arrangement is not only inequitable but also detrimental to the insurers profit margins.
In the long run, if many policyholders are under-insured, it may lead to financial instability of the insurer. A large scale of underinsurance will further lead to increase in rate to enable the insurer receive the premium income required to maintain and build up the funds necessary to meet the demands of legitimate members of insuring public.
Property insurances are annual contracts and it is not sufficient just to reassess the sum insured at the renewal date. Every insured person should keep track of the adequacy of the sums insured.
There are factors which arise such as the impact of inflation, market prices increases, government budget changes and replacement of older equipment for new, more expensive models, which all have the impact adequacy of the sum insured and the proposer should have them in mind. While fixing sum insured.
Reinstatement of the Sum Insured after Settlement of a Claim.
In settlement of property insurance claims, the sum insured is reduced by the amount paid, from the time of the loss to the next renewal date. This is because the insurer is deemed to have discharged their mandate for the portion of the sum insured for which they have paid for the loss. in other words, after the loss, what was insured- part of it – is no longer in existence and after the reinstatement, something new has been brought into subject matter of insurance.
Normally, the amount insured is restored to the original sum insured by an endorsement to that effect and an appropriate additional premium paid. As a result, the amount insured is reinstated to the original value. Occasionally the reinstatement premium is deducted from the claim.
The additional premium is charged on a pro rata basis from the date of reinstatement of the sum insured to the next renewal notice.
An exception to this rule is the declaration policy which deals with an insurance of stock. The policy wording provides that following a loss, the sum insured is automatically restored, the insured undertaking to pay necessary additional premium. Many industrial property policies regarding buildings and contents have a similar clause for automatic reinstatement of the sum insured following a loss.
Calculation of value
The value of an asset can be thought of its opportunity cost, that is, the loss or additional expense that the insured would incur if deprived of that asset. Again, the value of the subject of insurance and is its value at the time of loss and the place of loss.
Below are some of the guiding factors which are taken into account in arriving at the value in the various items insured in property insurance.
The usual basis for building is the cost of repair or reinstatement, hence to provide indemnity for buildings, the sums insured must take into account the wear and tear of the property insured. Reinstatement insurance exists whereby the sum insured and claim payments reflect the actual cost of rebuilding at the time of completion of work without wear and tear. A deduction may be necessary to compensate for betterment. Betterment may arise in two ways:
Additions and improvements which may be made in the course of rebuilding
The original building may have been in such a poor state of repair the rebuilding gives new for old.
In order to do the work quickly, the occupier of an industrial or commercial building often asks for an extra hour to be worked by contractors. The extra cost of this overtime is of the benefit of insured., as it helps to maintain turnover and production, and it should not be met under business interruption insurance.
However, the basis of settlement should not always be the cost of reinstatement or total loss. if an old fashioned country building is affected, the cost of restoring it to its pre-fire condition may be uneconomical.
For obsolete buildings, it would be impossible for insured to rebuild in the original manner. The basis of valuation is:
The cost of purchasing a building similar to the insured plus, if an allowance for removal of debris costs
The cost of erecting a modern building providing comparable facilities to the insured building plus, if insured, an allowance for professional fees, removal of debris costs and any additional expenditure in respect of local authority’s requirements. An agreement between the insured and insurer is necessary for this to apply.
The basis of indemnity is the cost of restoring the machinery to its previous condition particular where repair is possible. Where machinery is damaged beyond economic repair, the fairest recompense is the cost of replacing it by second machine of the same age, type, capacity and condition. To do this is not often practicable, however and so new machinery is often bought. There would then be obvious deduction because:
The original machinery may not be available and replacement will have to be by better and more modern machinery.
Replacement can be the same type of machinery but must be new for old and depreciation has to be taken into account.
Insurers do not offer solutions of buying an improved machinery because the approach can easily be misused. For the second approach, insurers could encourage for new machinery to be bought in place of old machinery of the same type by making insurance subject to the reinstatement memorandum.
Computer Equipment and Computer Records
A computer policy covers loss or damage resulting from any external cause such as fire, explosion, theft storm or flood and any form of electrical or mechanical breakdown while the equipment is in use.
The basis of indemnity is the cost of repair or replacement of the computer and its related equipment at current prices. The cost of removing damaged equipment and and debris after loss is covered, as is the cost of protecting the undamaged parts against further loss until repair or replacement is has been completed. For computer records, the normal basis of indemnity is the cost of labour and material necessary to reproduce them up to a specified period.
The basis of indemnity is the cost of production which includes the cost of raw materials, labour, factory overheads and administrative costs but excluding profit.
Where the total of the above items exceeds the market value of goods, the indemnity is the market value of the goods.
Wholesale and Retail Stock in Trade
The basis of indemnity is the price paid by the insured, not the selling price because the latter includes profits. The cost price can be ascertained from the supplier’s invoices. Discounts should be deducted, since the insured will obtain similar discounts when the goods are replaced by new stock. Deduction may have to be made for depreciation of stock through age particularly for goods which have become old –fashioned
Contract Price Clause
The element of profit is generally excluded when considering loss settlement in respect of stock, for this reason, a contract price clause is incorporated in the policy to provide against the possible cancellation of a contract of sale by reason of fire, if the insured has sold goods which are destroyed before delivery or which they are still responsible, and the contract is cancelled because of that reason, the insureds loss is measured by the contract.
The measure of indemnity for growing crops is the price of nearest market less the cost of combining or cutting, threshing and transport. For corn in stacks, threshing is deducted. For hay and straw in stacks, the basis is market price at the farm.
The measure of indemnity is the value at the time of the loss or damage based on the cost of replacement less an allowance for wear and tear.
Indemnity in livestock insurance is the market value at the place where and the time when the loss occurred. Claims usually occur from cattle rustling, fire lightning and diseases.
It is usual for claims to be supported by veterinary surgeon’s certificates which show the cause of the injury or death and the value of the vehicle.
In this class of business, the method adopted for calculating the value and sum insured differs from that employed with other classes of insurance. This is because the measurement of indemnity depends on the scope of the policy.
For insurance of boilers, the sum must cover not only their values and installation costs but the costs of possible damage to surrounding property, both belonging to the insured and belonging to other people as well.
The insurance should also include insurance liability for third party bodily injuries. It is therefore necessary to consider the value and proximity of third parties likely to be in the vicinity.