Cambridge Dictionary defines Sum Insured as “a maximum amount that an insurance company will pay to someone who makes a claim”.
This definition is at the heart of many on-going conflicts and debates in the Insurance world. As simple as it sounds from an Insurer’s perspective, it is an enigma for most buyers of insurance products. Buyers’ confusion is often compounded by ‘newer bitter discoveries’ at the point of truth; Claims. The objective of this primer is to be a simple ready reckoner of popular insurance policies for both, insurance professionals selling commercial lines products and buyers.
Some commonly used terms in context of sum insured are:
Market Value / Depreciated Value: Market value is the value of an asset as currently priced in the marketplace i.e. at which it can be sold or bought on ‘as it is’ basis. It would closely represent the present-day new cost of similar item / structure less the depreciation due to age / usage. This is, in most cases, different from the accounting Book value or the Original Purchase price.
Reinstatement Value: It represents the current ‘new for old’ replacement value of the asset. It represents the price of a new same or similar asset. Often it is included by incorporating “Reinstatement Value Clause” in the policy.
Average Clause / Under-Insurance: if the sum insured of a property at the time of loss or damage is less than its Market Value or Reinstatement Value (as per the policy conditions ), claim payment by the insurance company will be reduced in the same proportion.
| POLICY TYPE | BASIS OF SUM INSURED | BASIS OF CLAIM SETTLEMENT |
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1. Standard Fire & Special Perils (SFSP)
2. Burglary & Theft
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Option I
Reinstatement Value (RV) for all fixed assets and Market value (MV) for stocks. Reinstatement Value clause to be specifically mentioned. Option II Market value for all fixed assets and stocks. In the absence of Reinstatement Value specifically, policy is default treated as on Market value. |
Option I
Claim settlement on RV basis for all fixed assets after actual reinstatement of assets and MV for stocks. Insured can opt to take MV settlement for fixed assets with no reinstatement. Option II Claim settlement on Market Value for all fixed assets and stocks. |
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3. Industrial All Risk / Asset All Risk / Property All Risk
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Reinstatement Value (RV) for all fixed assets and Market value (MV) for stocks. (Some Insurers may agree for MV only for very old fixed assets, in which case, the claim settlement will also be on MV basis). | Claim settlement on RV basis for all fixed assets after actual reinstatement of assets within 12 months (or an extended period, if allowed by the Insurer) and MV for stocks. Insured’s option to seek MV settlement for fixed assets with no reinstatement. |
| For all policies above, average clause applies in all claim situations. Upto 15% Under-Insurance relaxation, under material damage section, can be mutually agreed in IAR / AAR / PAR policies. | ||
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4. Marine Cargo / Transit
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Predetermined valuation arrived at and hence these policies are on ‘Agreed Value’ basis between the Insurer and Insured. | Claim settlement on Agreed |
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5. Boiler and Pressure Plant CPM Electronic Equipment Machinery Insurance
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Reinstatement Value (RV) for all such equipment. (Some Insurers may agree for MV only for very old fixed assets / 2nd hand machines, in which case, the claim settlement will also be on MV basis). | Partial loss settlement on RV basis with no depreciation except limited life items. Total loss settlement on MV basis. Partial loss MV settlement with no reinstatement exists. Average clause applicable. |
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6. Project Insurance
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Completely erected value of the project including design fees, supplies, erection costs, freight, all taxes and duties. Any used equipment / machinery can be covered on MV basis or Refurbishment valuation report basis. | Loss settlement on Reinstatement Value basis. For Used equipment / machinery on MV or Agreed Value Average clause is applicable. |
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7. Business Interruption (Fire / Machinery)
Advance Loss of Profit – |
Annual Gross Profit and multiple of the same if the Indemnity period is more than 12 months. For Gross Profit, please refer to the specific definitions under the policy wording. Limited Premium refund provision exists. | Loss settlement on reduction in Gross Profit during the interruption period corresponding to the Indemnity period. Average clause is applicable. As the sum insured is adjustable based on actual, a buffer is always advisable. |
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8. Liability Policies
(CGL, D & O, PI, Cyber, Crime etc.) |
Limit of liability (LOL) to be selected by Insured basis of their own exposure analysis / specific contract values. | Any One Accident (AOA) & Any One Year (AOY) basis loss settlement |
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9. Employee (WC) compensation policy
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Sum Insured based Earnings of the covered employees which include wages, salaries, over time, board / lodging, any other perquisites | Claim settlement basis the award of judicial authority / body created for labour claims adjudication. Some Insurers’ may apply under insurance on claims if Earnings are understated. |
Understanding the average clause/ under-insurance clause:
- A new machine was purchased in 2010 for INR 10 lakhs. This is the Original Purchase Cost
- A used 2010 model can be bought for INR 6 lakhs in 2020. This is the Market Value of the machine
- The same new machine costs INR 20 lakhs in 2020. This then is the Reinstatement Value
- The machine has been depreciated @ 5% per annum, using Straight Line Depreciation method, in the books of the owner. Thus, the Book Value of the machine is INR 5 lakhs.
- If the Sum Insured of INR 5 lakhs is taken under the Fire Insurance policy, on Reinstatement Value basis, the insurer will apply 75% under-insurance and pay only 25% of each claim (INR 5 lakhs / INR 20 lakhs)
- If the Reinstatement Value Clause is not attached to the policy, the claim will be assessed with 16.66% under-insurance (INR 5 lakhs / INR 6 lakhs) after application of depreciation.
This Primer provides advice on broad principles only and is not intended to be an exhaustive review of your potential loss exposures. There may be many areas where further specialist advice is required. In such cases, please feel free to contact us.
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