The Underinsured Bakery Fire
Marco runs a small bakery in a leased unit. His commercial combined policy has a buildings sum insured of £180,000 and contents/stock of £40,000, with an average (underinsurance) condition. A fire caused by a faulty oven destroys the unit. The loss adjuster values rebuilding the unit at current rates at £260,000 and replacement of contents/stock at £55,000. Marco's lease makes him responsible for reinstatement of the building. He also faces three weeks' loss of trading while the unit is unusable, but his policy has no business interruption section. He assumed his insurance 'covered everything'.
1. Calculate the likely claims settlement for the building and contents, explaining the effect of the average condition.
Read the worked answer
The average condition applies proportionately where the sum insured is less than the value at risk.
Buildings: sum insured £180,000 ÷ value at risk £260,000 = 69.2%. Claim = £260,000 × 69.2% = £180,000, subject to the policy limit (the sum insured) and any policy excess. In practice, the insurer pays the proportion of the loss, but cannot exceed the sum insured, so the maximum recoverable is £180,000, leaving Marco bearing £80,000.
Contents/stock: £40,000 ÷ £55,000 = 72.7%. Claim = £55,000 × 72.7% = £40,000 (again capped at the sum insured), leaving £15,000 uninsured.
So Marco recovers roughly £220,000 against a true loss of £315,000. The average condition is the key mechanism: he is his own insurer for the shortfall. The lesson is to insure on a reinstatement (new-for-old) basis at current rebuilding costs, reviewed annually.
2. Explain why the trading loss is not recoverable and what Marco should have bought.
Read the worked answer
The policy contains no business interruption (BI) section. Property policies respond to physical damage only; they do not replace lost profit, wages or additional costs of working from another site. Marco assumed 'everything' was covered - a common and costly misconception.
He needed a BI extension (often called 'loss of profits' or 'consequential loss') with:
- an indemnity period long enough to rebuild and regain customers (three weeks is optimistic after a fire);
- a gross profit or turnover sum insured reflecting realistic trading;
- additional increased cost of working cover to trade from temporary premises.
A broker should have identified this gap at renewal. The firm should document the advice given and recommend BI cover going forward.