A Fire Claim and the Principle of Indemnity
A bakery's commercial combined policy covers buildings (£400,000 sum insured) and contents/stock (£120,000). In June a fire destroyed the shop fit-out and stock. The loss adjuster establishes:
- Reinstatement cost of the building: £520,000 (the sum insured is based on outdated 2019 figures).
- Contents/stock at the time of loss: £150,000 (the sum insured is £120,000).
- The policy is on a reinstatement as new basis for buildings and contents, with an average (underinsurance) condition.
- Business interruption cover is £200,000; the indemnity period is 12 months; the business was closed for 7 months and lost £90,000 of gross profit.
- The bakery had a £5,000 policy excess.
The insurer accepts liability. The insured argues it should receive the full cost of rebuilding and restocking because it paid premiums for years.
1. Calculate the likely settlement for buildings and contents, showing the averaging calculation.
Read the worked answer
Principle of indemnity: the insured should be restored to its pre-loss financial position, no better and no worse. Reinstatement cover modifies this (new for old), but the average condition still applies where the sum insured is inadequate.
Buildings:
- Sum insured £400,000; reinstatement cost £520,000.
- Average: claim × (sum insured ÷ value at risk) = £520,000 × (400,000 ÷ 520,000) = £520,000 × 0.769 = £400,000.
- Less excess £5,000 → £395,000.
Contents/stock:
- Sum insured £120,000; value £150,000.
- Claim × (120,000 ÷ 150,000) = £150,000 × 0.8 = £120,000.
- Less excess (if a separate excess applies; otherwise already deducted) → £115,000 if separate.
Business interruption: the gross profit loss of £90,000 is within the £200,000 limit and the 7-month closure is within the 12-month indemnity period, so it is payable in full (subject to any BI excess and the trend/adjustment clauses).
The insured's argument that 'I paid premiums for years' does not override the average condition: the premium was calculated on the (inadequate) sums insured. The remedy is to increase sums insured at renewal and index-link them.
2. What practical steps should the broker have taken to prevent this outcome?
Read the worked answer
- Accurate sums insured: use a professional rebuild valuation (not a market value) and index-link annually; for contents/stock, base the figure on maximum stock levels, not average.
- Declarations: where stock fluctuates, consider a declaration-linked or floating sum insured policy.
- Explain average: make clear in writing that underinsurance reduces claims proportionately, and record the advice.
- Reinstatement basis: confirm the insured understands 'reinstatement as new' still requires an adequate sum insured.
- Review at renewal: revalue after any fit-out, extension or significant stock change.
The broker's file note and written recommendation are the best defence if a complaint follows.