Fire renewal after a preventable loss: capacity, protection and sum insured
A cotton-yarn spinning mill seeks renewal of its standard fire and special perils policy. The reinstatement value of buildings, plant and stock is ₹18.4 crore, but the broker has proposed a sum insured of ₹12 crore to keep premium competitive. In the expiring year the mill had one fire loss of ₹86 lakh, traced to an electrical short circuit in the yarn store; the claim was paid. The surveyor's risk-improvement note required three actions: a four-hour fire wall between the yarn store and the spinning hall (completed), a high-velocity water-spray system (not installed; quoted ₹41 lakh), and replacement of three oil-filled transformers (two replaced). The insured's loss ratio on this policy is 143%. The broker asks for a 5% deductible and a 15% commission, and says two other insurers have declined. Renewal is due in nine days. The underwriter's personal authority is ₹10 crore sum insured per risk; anything above requires facultative support, and the facultative market is currently quoting only for risks with full automatic sprinkler protection.
1. Identify the underwriting issues that drive your decision and state the terms, if any, on which you would offer renewal.
Read the worked answer
The decision turns on three linked issues. First, the sum insured is 35% below reinstatement value (12 vs 18.4), so the average clause will reduce every claim; the competitive premium is buying less protection, not a better price. Second, the most important risk-improvement item, the HVWS in the yarn store, is outstanding, and the expiring loss originated in that area; writing the risk unchanged repeats the loss. Third, two declinatures and a 143% loss ratio are adverse-selection signals that justify stricter terms. My offer: sum insured ₹18.4 crore on reinstatement basis with average clause, 10% deductible subject to a minimum, and a warranty that the HVWS is commissioned within 90 days, with monthly progress reports; transformers to be certified by a licensed electrical inspector. Because ₹18.4 crore exceeds my ₹10 crore authority and facultative support requires sprinklers, I would quote only subject to survey and facultative placement, and not bind cover until placed. If the insured insists on ₹12 crore, I decline rather than write a policy that will disappoint at claims stage.
2. The broker argues that a lower sum insured lowers the premium and that the average clause only matters after a loss. Explain how you would quantify and communicate the effect of underinsurance using a claim example.
Read the worked answer
At ₹12 crore, a ₹6 crore fire loss is paid at 12/18.4 × 6 = ₹3.91 crore, leaving ₹2.09 crore uninsured. At ₹18.4 crore and a 0.18% rate the premium is ₹3.31 lakh; at ₹12 crore it is ₹2.16 lakh, a saving of ₹1.15 lakh. The insured is trading a ₹1.15 lakh saving for a ₹2.09 crore gap on a single mid-sized loss, roughly 18 times the saving. I would put this in a letter, with the worked example, and ask the broker to obtain the insured's written acknowledgement of the average clause. I would also check the basis of valuation: if the policy is reinstatement, the sum insured should reflect rebuilding cost, not book value. If cash flow is the issue, offer a higher deductible or instalments, not underinsurance. Record the advice in the underwriting file because a later dispute will turn on whether the consequence was explained.
3. The broker says two other insurers have declined. How much weight should that carry, and what would make you walk away?
Read the worked answer
It is information, not a verdict. I would ask each declinature for its reason: protection, loss ratio, capacity, or suspicion of moral hazard. If the declines were for protection, my conditions address that. If they were for suspected arson or misrepresentation, I need much more before writing. I would not follow the market blindly in either direction, but three declinatures plus a 143% loss ratio shift the burden of proof onto the insured. I would walk away if the HVWS remains uninstalled at renewal, if the insured refuses to insure at reinstatement value with the average clause, or if the facultative market will not support the excess over my ₹10 crore authority. I would also walk away if the broker cannot explain the two declines or pressures me to backdate cover. Declining a bad risk is a better outcome than writing a policy that cannot be placed or will be repudiated later.