The Total Loss on an Undervalued Building
A factory owner insures its building for BGN 800,000, although the rebuilding cost is BGN 1,000,000. The policy is a fire policy with an average (proportional) clause and a BGN 10,000 deductible. A fire causes BGN 400,000 of damage to the building. Separately, the same fire destroys machinery insured under a separate policy with a BGN 500,000 sum insured and an actual value of BGN 500,000. The owner also claims BGN 60,000 for business interruption, but the fire policy contains no business-interruption extension. The insurer has already paid BGN 15,000 to a contractor for emergency shoring at the owner's request.
1. Calculate the indemnity payable on the building and explain the effect of the average clause.
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Step 1 – Identify underinsurance. Sum insured BGN 800,000 vs. value at risk BGN 1,000,000 = insured at 80% of value.
Step 2 – Apply the average clause. The insurer pays the loss in the same proportion as the sum insured bears to the value:
Loss × (Sum insured ÷ Value) = 400,000 × (800,000 ÷ 1,000,000) = 400,000 × 0.8 = BGN 320,000.
Step 3 – Deductible. Subtract the BGN 10,000 deductible: 320,000 − 10,000 = BGN 310,000 payable.
Step 4 – Principle. The average clause enforces indemnity: the insured must not recover more than the proportion of loss it actually insured. The owner bears BGN 90,000 of the loss (the uninsured 20% plus the deductible). This is a judgement about proportionality, not a fixed formula memorised - the clause applies only because the policy contains it.
2. How should the claims for the machinery and for business interruption be treated, and what is the significance of the BGN 15,000 already paid?
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Machinery: Insured for BGN 500,000 against actual value BGN 500,000 - no underinsurance, so no average reduction. Subject to its own deductible and any limits, the machinery loss is indemnified in full up to the sum insured, less any deductible in that policy.
Business interruption: The fire policy has no BI extension. There is no cover, so nothing is payable under that policy regardless of how genuine the loss is. The owner may have a separate BI policy, but the fire policy cannot be stretched to cover it. This tests the boundary of what the contract actually covers versus what the client assumed.
The BGN 15,000 payment: A payment made by the insurer for emergency shoring is a mitigation/salvage expense incurred to reduce the loss. Whether it is recoverable in addition to the indemnity depends on the policy's sue-and-labour/mitigation clause. If the policy covers such expenses in addition to the sum insured, it does not erode the BGN 310,000; if it is within the sum insured, it must be accounted for. The key point is that the payment does not convert an uncovered BI loss into a covered one, and the broker should confirm the clause wording before advising the client.