The Commercial Fire Claim and Underinsurance
A small bakery has a buildings sum insured of £400,000 and contents sum insured of £60,000 on a commercial combined policy. A fire destroys the shopfit and stock. The loss adjuster assesses the reinstatement cost of the buildings at £520,000 (the policy is on a reinstatement basis) and the contents at £75,000. The policy has a average (underinsurance) condition, a £1,000 excess, and a 90-day business interruption indemnity period. The bakery's gross profit is £180,000 a year and it expects to be closed for four months. The policy also has a condition of average and a requirement to keep accurate records.
1. Calculate the likely settlement for the buildings and contents losses, showing the effect of average.
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Buildings: sum insured £400,000; reinstatement cost £520,000.
- Average applies: settlement = loss × (sum insured ÷ value at risk).
- If the building loss is the full £520,000, the insured receives £520,000 × (400,000 ÷ 520,000) = £400,000, less the £1,000 excess = £399,000. The shortfall of £120,000 is borne by the insured.
Contents: sum insured £60,000; value £75,000.
- Settlement = £75,000 × (60,000 ÷ 75,000) = £60,000, less excess. (The excess normally applies once per claim, not per section, depending on policy wording - check.)
Key judgement: the condition of average means the insured is a co-insurer for the shortfall. The bakery should have insured to full reinstatement value. The £1,000 excess is deducted once per claim under most commercial wordings. The insured cannot recover the shortfall from the insurer; it is a self-insured loss. The adviser should recommend a professional valuation and index-linking of sums insured at renewal.
2. Explain how the business interruption claim is likely to be treated over the four-month closure.
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Business interruption cover indemnifies loss of gross profit (and increased cost of working) during the indemnity period, which here is 90 days - shorter than the expected four-month (about 120-day) closure.
- The policy responds for the first 90 days of the interruption, not the full four months. The final ~30 days of lost gross profit are uninsured unless the indemnity period is extended.
- The BI sum insured must reflect annual gross profit (£180,000); if it is set too low, average applies to BI too, reducing the payout proportionately.
- Increased cost of working (e.g. temporary premises, equipment hire) may be recoverable if it reduces the loss, subject to the policy's limits.
- The insured must keep accurate records - the condition requires books and records to be maintained and produced; failure can prejudice the claim.
Judgement: the 90-day indemnity period is a material gap for a business with a four-month rebuild. The adviser should recommend extending the indemnity period to at least 6–12 months and reviewing the BI sum insured annually. The records condition means the bakery must be able to substantiate the gross profit figure.