Reinstatement Value Policy: Capital Additions, Average and the Undeclared Line
A pharmaceutical manufacturer in Ahmedabad insures plant and machinery under a Standard Fire and Special Perils policy on a reinstatement value basis. The sum insured is ₹10.00 crore. The policy contains a capital additions clause covering new additions up to 5% of the sum insured, and a reinstatement value condition that includes average. Three months before the fire, the insured installed a new packaging line costing ₹1.20 crore and did not declare it. At the time of the fire, the reinstatement value of all plant and machinery at the premises, including the new line, is ₹13.70 crore. The fire destroys machinery whose current replacement cost is ₹6.00 crore; there is no salvage. The new packaging line is undamaged. The policy deductible is ₹10 lakh. The insured claims ₹6.00 crore less the deductible, arguing that a reinstatement value policy pays new-for-old and that the new line was never declared, so it should not affect the claim.
1. Calculate the insurer's liability for the damaged machinery, showing each step. State whether the undamaged new packaging line belongs in the average calculation.
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Effective sum insured: ₹10.00 crore plus capital additions of 5% = ₹10.50 crore. The new line cost ₹1.20 crore, so only ₹0.50 crore is automatically included; the balance of ₹0.70 crore was never declared and is not covered for its own damage. For average, the denominator is the reinstatement value of the whole property insured by the item, not just the damaged property: ₹13.70 crore. Average factor = 10.50 / 13.70 = 0.7664. Loss = ₹6.00 crore × 0.7664 = ₹4.5985 crore. Less deductible ₹0.10 crore = ₹4.4985 crore, say ₹4.50 crore. The undamaged packaging line belongs in the denominator because average tests whether the sum insured is adequate for the entire subject matter at risk. If the insured had declared the line and increased the sum insured to ₹13.70 crore, the factor would be 1.0 and the claim would be ₹5.90 crore after deductible. The insurer should not exclude the line from the denominator merely because it was undeclared; that would reward under-insurance.
2. The insured argues that the capital additions clause should automatically cover the full ₹1.20 crore because the line was a capital addition. Evaluate that argument.
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The clause does not automatically cover the full ₹1.20 crore. It covers new additions up to 5% of the sum insured, i.e. ₹0.50 crore, usually without additional premium and often subject to a time limit for declaration. The remaining ₹0.70 crore is outside the automatic cover. The insured's argument fails for two reasons. First, the clause is a limited automatic extension, not an agreed value for all capital additions. Second, the fact that the line is undamaged does not remove it from the average calculation. Average is concerned with the relationship between the sum insured and the value of the whole risk; selecting only the damaged items would allow an insured to insure one part of a plant and leave the rest uninsured while still claiming as if fully insured. The insured can ask the insurer to consider a discretionary settlement for the undeclared line only if it can show a genuine oversight and the policy has a declaration or average-waiver provision; absent that, the calculation stands. A mid-term endorsement increasing the sum insured would have avoided the gap, but it cannot be applied retrospectively after the loss.