Settling a factory fire claim with under-insurance and a second policy
Fortune Plastics Ltd holds a Standard Fire and Special Perils policy from Insurer A: building (owned, on reinstatement basis) sum insured ₹2,00,00,000, and stock and stock-in-process ₹1,50,00,000. The policy carries a ₹50,000 excess each and every loss and the usual average (under-insurance) condition. On 12 June a fire destroyed the mixing section. The surveyor records: damage to the building ₹50,00,000; stock destroyed with a book value of ₹60,00,000, of which ₹4,00,000 was salvaged and sold by the insured; the reinstatement cost of the building at the date of loss ₹2,50,00,000; stock actually held at the date of loss ₹2,40,00,000. The insured also discloses a second policy with Insurer B, taken three months earlier, for ₹50,00,000 on the same stock, on the same conditions. The insured argues that because the policy is on reinstatement value the average condition should not apply, and that in any case he should receive the full ₹56,00,000 for stock because he paid two premiums.
1. Compute the amount payable by Insurer A, ignoring the second policy for the moment, and show each step.
Read the worked answer
Building. Loss ₹50,00,000; sum insured ₹2,00,00,000; reinstatement cost at the date of loss ₹2,50,00,000. Average applies on reinstatement cost: 50,00,000 × 200/250 = ₹40,00,000. The building was underinsured by 20%.
Stock. Gross loss ₹60,00,000 less salvage realised ₹4,00,000 = ₹56,00,000 net loss. Sum insured ₹1,50,00,000 against stock of ₹2,40,00,000 actually held: 56,00,000 × 150/240 = ₹35,00,000. The insured carries 37.5% of the stock loss himself.
Total. 40,00,000 + 35,00,000 = ₹75,00,000 gross; less the ₹50,000 policy excess once for the loss = ₹74,50,000.
Two points of method: salvage is deducted from the loss before the average is applied, because the insured must not recover more than the indemnity; and the sum insured is compared with the value at risk at the date of loss, not with the value at inception. The gap between ₹1.50 crore of cover and ₹2.40 crore of stock is the whole reason for the shortfall, not any dispute about the quantum of damage.
2. How does Insurer B's policy change the outcome? Show the contribution arithmetic and state whether the insured ends up fully indemnified.
Read the worked answer
With both policies, the stock is insured for ₹1,50,00,000 + ₹50,00,000 = ₹2,00,00,000 against a value at risk of ₹2,40,00,000. The loss still exceeds the aggregate cover in the same proportion.
Admissible on stock across both insurers: 56,00,000 × 200/240 = ₹46,66,667.
Rateable contribution:
- Insurer A: 150/200 × 46,66,667 = ₹35,00,000
- Insurer B: 50/200 × 46,66,667 = ₹11,66,667
Insurer A's stock liability is unchanged at ₹35,00,000, because A's own average ratio (150/240) and its rateable proportion (150/200 of an aggregate that is itself averaged at 200/240) produce the same figure. A therefore pays ₹40,00,000 (building) + ₹35,00,000 (stock) − ₹50,000 excess = ₹74,50,000, as before.
Is the insured fully indemnified? No. Combined recovery on stock is ₹46,66,667 against a ₹56,00,000 loss: ₹9,33,333 remains uninsured. Two premiums bought two policies, not two indemnities. The insured's expectation of ₹56,00,000 would also be a profit-seeking recovery, which the principle of indemnity does not permit. Insurer A should, however, obtain B's policy and settlement details before paying, and record the contribution so that no double payment occurs.
3. Rule on the reinstatement argument, and state what you would put in the renewal recommendation.
Read the worked answer
The argument fails. Reinstatement value basis and the average condition are separate things. Reinstatement basis fixes how the sum insured is to be measured - the cost of rebuilding, not depreciated value. Average then enforces the consequence of that measurement: if the declared sum insured falls short of the reinstatement cost, recovery is reduced in proportion. Applying reinstatement basis without average would reward under-declaration, because the insured would collect new-for-old on a figure that was never enough to rebuild.
On the facts, the average condition bites precisely because the building was carried at ₹2.00 crore against a reinstatement cost of ₹2.50 crore - evidence of under-insurance, not an argument against the clause.
Renewal recommendation:
- Re-fix the building sum insured at the current reinstatement cost and re-test it at each renewal and after any capital expenditure; index it between renewals.
- Replace the fixed stock sum insured with a floater or declaration policy if stock swings between ₹1.5 crore and ₹2.4 crore, so cover tracks the value at risk instead of lagging it.
- Require disclosure of every policy on the same property at proposal and at renewal, with a warranty that no other cover exists. Insurer A should also consider whether the earlier non-disclosure of Insurer B's policy affects the current claim or only the renewal terms.
- Where two policies are genuinely wanted, structure them deliberately as a co-insurance arrangement with agreed shares, rather than as two overlapping covers that only produce a contribution exercise.