The sum insured is an extremely important aspect of a contract of insurance and it has been seen from experience that more often than not the sum insured is not fixed on a proper basis. In most of the claims, where proper indemnity could have been given had the sum insured been adequate, the losses stand proportionately reduced because of under insurance. Adequacy of the sum insured is important from the point of view of all concerned- the insured, the insurer, the surveyor and the bank or financial institution who may have an interest in the subject matter of insurance.

Importance of fixing proper sum insured

Before we look into the subject of fixing proper sum insured, let us see how the contract of insurance operates. A contract of insurance is defined as "a contract whereby one party, called the Insurer, in consideration of premium paid by another party, called the Insured, agrees to indemnify the latter in the event of loss or damage to the subject matter of insurance due to any of the insured perils as per the terms and conditions of the policy.

In the case of a Fire Insurance contract, the sum insured should be adequate, because the policy provides for an Average Clause whereby the assessed claim is reduced in proportion to the under-insurance. The average clause is reproduced below:

If the property hereby insured shall at the breaking out of any insured peril be collectively of greater than the sum insured thereon, then the insured shall be considered as being his own insurer for the difference for the difference, and shall bear a rateable proportion of the loss accordingly. Every item, if more than one , of the policy shall be separately subject to the condition.

Since the purpose of the insurance is to place the insured in the same financial position in which he was at the time of loss, it is necessary that there should be no under-insurance and the sum insured be adequate.

Fixing of adequate sum insured is also important from the point of view of the banks or financial institutions who may have advanced money on the security of the insured property. It is sometimes found that the banks or financial institutions do not concern themselves with the adequacy of the sum insured so long as it is sufficient to cover the money advanced by them or at best the full value of the property on which they have advanced money. Invariably in such cases they find the problem only after happening of a loss when the claim amount is suitably adjusted for underinsurance and the full indemnity is not available due to the inadequacy of the sum insured.

Fire Material Damage Policies – Sum Insured

The sum insured is always fixed by the proposer.

It is the limit of Insurer’s liability under a policy.

It is the amount on which the rate is applied to determine the premium payable for the insurance.

The sum insured should represent the actual value of the property to be insured. Insuring for higher value than the actual value gives no advantage to the insured as payment of claim, if, any, is subject to the principle of indemnity.

Insuring for value lesser than the actual value makes the insured self insurer for the difference and claim, if any, is subjected to ‘average’ clause whereby he is penalized for under-insurance.

In case of joint ownership of any property, the insured can get the claim only in respect of is share. He could, however, insure full value of the property on behalf of other co-owners as well which case the claim, if any, is paid to each co-owner to the extent of their insurable interest.

It is, therefore, important to determine the sum to be insured very carefully. It is suggested that this should be based on each of various items i.e building, plant, machinery, contents, etc.

Buildings

For insurance of building one has to take into account various factors and ensure that the value of the land is excluded since the land cannot be damaged by fire or allied perils. The plinth and foundations normally do not get damaged but in the event of a series fire, they can be so affected as to require re-doing. The present day value of plinth and foundations is substantial and therefore if the intention is to insure its value, it is suggested that this must be separately declared. In case the intention is not to insure plinth and foundations against fire and allied perils it may still be considered for insurance ageist ‘earthquake fire and shock ‘ risks for which there is a suitable provision for insuring these a separate item without corresponding insurance against fire perils. In other words, the sum insured against earthquake risk on that portion of the building above the ground level will be same as the sum insured under fire policy but the plinth and foundations will be insured under a separate item if it is desired to be included against earthquake peril. The value of the building should be computed taking into account the cost of floors, walls, roofs/false roofs/ceilings and value of such items which may be embedded underground or in the walls/roofs which such become integral part of the building. The intention of including such items must be clarified by suitable description in the policy itself in order to avoid any future confusion/misunderstanding. Examples of items which embedded underground or in walls/ roofs are:

Pipes

Electric and telephone wirings or other items used for special purpose.

Valuation

Buildings are usually insured on one of the following bases by the insured:

Original Cost

Book Value

Market Value

Reinstatement Value
and the sum insured for each basis will obviously differ.

Original Cost

Every new building has its original cost at which it has been acquired and is atleast relevant during the first year of its insurance. For old buildings the original cost has n relevance to its value for insurance purpose since it is subject to depreciation due to its age and also appreciation in value due to inflation.

Book Value

Book value of a property has no relation to insurable value except in the case of new building in its first year of insurance. In the subsequent years, the book value continues to be brought down by depreciation and as such it does not represent market value or the value of similar new property.

Market Value

This is determined by the amount at which property of the same age and condition can be bought and sold. This value takes into account both depreciation due to age and appreciation due to inflation. For determining the sum insured for buildings, apart from excluding the value of land and plinth, the present cost of construction of similar building should be taken and then the depreciation for age and usage deducted.

Reinstatement Value

This means the value of similar new property. In fire insurance the principle of indemnity can be modified in the case of building, machinery and other fixed assets whereby, subject to the sum insured representing the value of similar new property, it can be insured under ‘Reinstatement Value’ clause. In case of reinstatement value policy, the basis of loss settlement is the value of new property without taking any depreciation into account. This type of insurance enables the owner to replace his property without any financial strain on his own resources and is quite commonly taken by industrialists and building owners.

Each building has a definite built up area and ascertainable constructional specification. Any civil engineer or architect can examine the current cost construction, keeping all relevant factors in view. For arriving at the cost of buildings, various publications such as CPWD rates are available as guideline. In case of old buildings if an escalation method is to be made use of, the cost of rise indices published by the National Buildings Organisation should be referred to for arriving at present value for insurance purposed. Depreciation in the case of building is to be adjusted from the estimated current replacement cost. Calculation of depreciation may vary considerably and therefore each individual building will require fixation of depreciation on merit taking various features, interalia construction, occupancy (some occupancies generating heat/vibration will require higher rates of depreciation), degree and standard of maintenance. It is therefore, very difficult to have a fixed formula and yet merely as a rough guideline the following range could give some indication

CHECK LIST

A. BUILDINGS
A.1		Check if the following values included or excluded:
	i)		Land value (It should not be included since it cannot be damaged by fire.)		Yes/No
	ii)		Foundation/Plinth (Not to be included for fire peril but may be shown as a separate item in case earthquake fire and shock peril is taken.)		Yes/No
	iii)		Underground assets (May be included since they may get damaged in case of a serious fire and also liable for damage due to flood, inundation, earthquake fire and shock. If included, it should be so described in the Policy.)		Yes/No
	iv)		Assets embedded in walls, roofs, floors (These should be included and so described in the Policy.)		Yes/No
	v)		Road and Pavement		Yes/No
	vi)		Boundary walls and fences		Yes/No
	vii)		Utility Buildings (Should be included and so described in the Policy)		Yes/No
A.2		Check the basis of valuation
	i)		Original Cost		These will result in under insurance
	ii)		Book Value
	iii)		Market Value of similar property		Correct basis for taking standard fire policy
	iv)		Reinstatement Value (value of similar new property)		Correct basis for taking policy with Reinstatement Value Clause

Note: A monthly, quarterly or semi-annual revision in values is recommended.

B. PLANT AND MACHINERY
B.1		Check if the following included:
	i)		All items of Plant and Machinery including electrical items	Yes/No
	ii)		Standby Machinery not in use	Yes/No
	iii)		Tools and spares on shop floors or in stores/godown	Yes/No
	iv)		Transformers and distribution system(if owned, it must be insured, otherwise can be insured on behalf of the Electricity Board Concerned	Yes/No
B.2		Check the basis of valuation:
	i)		Original Cost	These will result in under insurance
	ii)		Book Value
	iii)		Market Value of similar property	Correct basis for taking standard fire policy
	iv)		Reinstatement Value (value of similar new property)	Correct basis for taking policy with Reinstatement Value Clause

Note: Periodical revision in value is recommended.

B.3		For Imported machinery check the following:
	i)		Inflation in the country of origin
	ii)		Change in custom duty
	iii)		Currency fluctuation

C. STOCKS AND STOCK –IN – PROCESS
	Check if following have been included
		i) Raw Materials InGodowns In Open On the Shop Floor In bonded Warehouse	Yes/No
		ii) Finished Goods In Factory In finishing/packing Department In Open In Godowns In Bonded Warehouse	Yes/No
		iii) Stock –in-process (Care may taken to estimate maximum value at each location)	Yes/No
		iv) Wastes	Yes/No

D. COMMON POINTS
Has escalation clause been taken for:
	i)		Anticipated inflation during policy period for buildings and plant & machinery	Yes/No
	ii)		Declaration facilities for stocks	Yes/No
	iii)		Removal of Debris for Buildings and Machinery	Yes/No
	iv)		Spoilage cover for stock in process	Yes/No
	v)		Omission to insure addition etc for building and machinery	Yes/No
	vi)		Other additional covers that may be added to fire policy, such as insurance of rent etc	Yes/No

 

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