Whenever you opt for property insurance coverage, the first information you will have to provide to the insurance company is the value of the property to be covered, referred to as the sum insured in insurance terms. Many times we have observed that clients are not able to provide an accurate value of the sum insured for coverage of property due to the following factors –
- The building in which the client’s business is running was constructed 10 years ago. What can be the optimum sum he should take for the building cover? Shall it be the construction cost incurred 10 years ago, the depreciated value as per the book of accounts, or the current market value?
- Machinery and other business-related assets were added from time to time as the business grew. Some machines are 10 years old, some are 7, some are 5, some are 2, and purchased some recently. How does one account for the value of machinery for insurance? Shall it be as per the purchase invoice, as per their present book value, or current market value? How does one determine the market value of old machinery, because there is no structured marketplace for these items?
Key Takeaways
-
Usable Life vs. Book Value: Insurers do not use the aggressive depreciation seen in your accounting books; they assess depreciation based on the remaining usable life of the asset.
-
The “New for Old” Benefit: Reinstatement value is highly preferred for machinery and buildings because it pays the full cost to replace a damaged old asset with a new one, subject to the policy limit.
-
Strictly Fixed Assets: You cannot use Reinstatement Value for stocks or goods in process; these are always covered on a Market Value basis.
-
The 12-Month Clock: To benefit from the Reinstatement clause, the repair or replacement must typically be completed within 12 months of the loss, or the insurer will revert the payout to Market Value.
-
Avoid Under-Insurance: The Sum Insured must be equal to or greater than the current cost of a new replacement. If you insure an old machine for its original 10-year-old price, you will be penalized by the “under-insurance clause.”
-
Betterment Contribution: If you replace a damaged machine with a more efficient or higher-capacity model, you are responsible for paying the proportional difference for that “upgrade.”
We have highlighted the two most important queries in deciding the sum insured. I am sure you have much more specific to your business or trade.
Let us understand the methods of coverage in a fire and a special perils insurance policy that will help provide you with the answer to the right thing to do. Fire and special perils insurance policies can be provided on two sum insured terms – Market value and Reinstatement value respectively.
-
Market Value –
For the market value method, in the event of loss, depreciation is levied on the asset depending on the age of the asset. It is important to note that deprecation considered by insurers for claim settlement purposes is based on the remaining usable life of the respective asset and not its depreciated value in the book of accounts. Generally, the depreciation in the book of accounts is more aggressive. Compared to the insurer’s assessment based on the remaining usable life of the asset. Whatever the case, this method does not pay the insured an amount sufficient to buy the replacement of the asset. Hence most clients prefer the reinstatement value method for covering their assets, described below.
-
Re-instatement Value of property sum insured
As per the reinstatement value method, the insurance company will pay the cost of the replacement of the asset subject to the ceiling of the sum insured under the policy. The policyholder is not charged for depreciation or general wear & tear during claim settlement under this method. Since the insurance company pays the cost of replacement of the damaged old asset with a new one. Also, known as the New for Old clause, for ease of understanding.
Summary Table: Sum Insured Calculation Methods
| Feature | Market Value (Depreciated) | Reinstatement Value (New for Old) |
| Depreciation | Applied based on the asset’s remaining usable life. | Not Applied; wear and tear is ignored. |
| Payout Goal | Reimburses the “current value” of the old asset. | Reimburses the cost to buy a new equivalent. |
| Applicability | All assets, including stocks and work-in-process. | Fixed Assets only (Buildings, Machinery, Furniture). |
| Valuation Source | Current replacement cost minus age-based deduction. | Current market price for a new, similar asset. |
| Replacement Rule | No obligation to actually replace the item. | Must repair or replace within 12 months to claim. |
| Risk of Gap | High (Policyholder must fund the “new” difference). | Low (If Sum Insured is set correctly). |
However, there are a few points to keep in mind regarding how claims are settled under the reinstatement value clause –
A. Reinstatement value clause, allowed only for fixed assets. It does not apply to stock and work-in-process items.
B. The sum insured in the policy should be equal to or greater than the reinstatement or replacement value of the asset. In case the sum insured is less, the underinsurance clause will be applicable.
C. Re-instatement value claim, made if the damaged asset is repaired or replaced. Generally, insurers allow up to 12 months to reinstate the asset. You can seek an extension to the timeline with a reasonable explanation. However, in the case that reinstatement does not perform within the stipulated timeline. The insurer will settle the claim on a market-value basis.
D. Insurer’s liability is to reinstate the damaged asset with a similar one in terms of productivity and efficiency. In case the insured replaces the damaged asset with one that has better productivity or higher efficiency. The insured has to contribute to the reinstatement cost in a similar proportion to the increasing inefficiency.
Frequently Asked Questions (FAQs)
1. If my building were built 10 years ago, what value should I declare for the Sum Insured?
A) For the best protection, you should declare the current cost of construction for a similar building today (Reinstatement Value). Declaring the construction cost from 10 years ago will lead to significant under-insurance, meaning you won’t have enough money to rebuild.
2. How do I value a machine that is no longer manufactured?
A) If the exact model is unavailable, the Sum Insured should be based on the cost of the nearest modern equivalent that provides similar productivity and efficiency.
3. What happens if I choose Reinstatement Value but decide not to rebuild my factory after a fire?
A) If you choose not to reinstate (repair or replace) the property, the insurance company will settle the claim on a Market Value basis. This means they will deduct depreciation for the age of the building or machinery from your payout.
4. Does Reinstatement Value cover the cost of upgrading to better technology?
A) No. The insurer’s liability is to return you to the same level of productivity you had before. If you install a machine that is 20% more efficient than the old one, you will have to pay for that 20% “betterment” out of your own pocket.
5. Why is under-insurance such a big risk for old machinery?
A) Because the “under-insurance clause” compares your Sum Insured to the current replacement cost. If a new machine costs ₹10 Lakhs but you only insured your old one for ₹5 Lakhs, the insurer will only pay 50% of any claim, even for minor repairs.
About The Author
Shivani
MBA Insurance and Risk
She has a passion for property insurance and a wealth of experience in the field, Shivani has been a valuable contributor to SecureNow for the past six years. As a seasoned writer, they specialize in crafting insightful articles and engaging blogs that educate and inform readers about the intricacies of property insurance. She brings a unique blend of expertise and practical knowledge to their writing, drawing from her extensive background in the insurance industry. Having worked in various capacities within the sector, she deeply understands the challenges and opportunities facing property owners and insurers alike.
