An escalation clause or phrase in a fire insurance contract effectively allows for an increase in the sum insured to cover any unexpected costs which may arise from fluctuations. It simply means, that should inflation increase the price of items, for instance, these costs will be covered under a fire insurance policy as well.
While it is necessary to have comprehensive fire insurance to get coverage against losses or damages arising due to fire. It is also necessary to consider inflation while buying the cover as there is no point in being underinsured. The escalating inflation rate, for example, can result in hidden costs and increase the price of items.
Further, the escalator clause is also called the inflation-guard endorsement in the insurance business. As it helps in increasing your insurance cover as per the current labour costs, raw materials, and so on.
Remember, inflation is a devil which can easily increase the price of any goods. Therefore, if you plan to cancel the escalator clause in fire insurance in order to save money, you would have to dig deep into your pocket, should your business or asset get damaged due to fire. As they say, penny wise, pound foolish, do look at the escalation clause at the time of buying a fire insurance policy. In order to ensure that your cover always stays in sync with the prevailing market scenario.
Case 1: Escalation Clause in Fire Insurance
After working for five years in the corporate world, Jayant Gupta started his own software company in Pune. Jayant also bought a fire insurance policy to get coverage against loss or damage which may arise due to fire. At the time of buying a fire insurance policy, Jayant computed the cost of all the assets and decided to go with a fire insurance cover of Rs 5 lakh. The cover was not sufficient as per the cost of the assets. However, in a bid to save money, Jayant preferred to go with a low fire insurance cover. Moreover, when the agent suggested he go with an escalation clause in a fire insurance policy, he refused it.
Unfortunately, last year, the fire occurred at Jayant’s office due to short-circuit. Though no one was injured, property worth Rs 10 lakh got damaged. As Jayant had a fire insurance policy, he approached the insurer for the claim settlement. Here, the insurer found that the total loss was Rs 10 lakh, however, Jayant had a cover of Rs 5 lakh only, and settled the claim accordingly.
Above all, Jayant had bought a fire insurance policy when his office was under construction. At that time, the value of the property was less, which increased in five years. However, as Jayant did not include an escalation clause in his fire insurance policy, the insurance company settled the claim. It was as per the coverage value only which was not sufficient.
Here, Jayant committed the following two mistakes=
- Bought a fire insurance cover which was not sufficient
- Refused to add an escalation clause in a fire insurance policy
Jayant’s situation would have been different if he had purchased a fire insurance cover with an escalation clause. In the case of the escalation clause, the insurer would have considered the current value of the property at the time of claim settlement.
Additional read: How is indemnity estimated in fire insurance
Rajni Saran started her engineering company in Delhi. She decided to buy a fire insurance policy to secure herself from financial troubles that could arise in case there was a loss or damage due to the fire. On the advice of her insurance broker, she also included an escalation clause in her fire insurance policy.
Last year, a fire erupted at her company due to short-circuit, and she lost goods and machinery worth Rs 10 lakh in the fire. She approached her fire insurance company. As Rajni had also included an escalation in her fire insurance policy, the insurer considered the current price of machinery to settle the claim.
Without an escalation clause, the insurer would have settled the claim as per the cover. Thanks to the escalation price, the insurer considered the inflation as well at the time of claim settlement.