Construction plant and equipment requires substantial capital investment. It is therefore important that the sum insured requirements are correctly reflected in the insurance policy concluded by the owner of the equipment. Consort wishes to point out certain important aspects to assist you in arranging the correct Plant All Risks insurance for your client.
Understanding the meaning of sum insured
Sum insured is commonly described as, “a maximum amount that an insurance company will pay to someone who makes a claim.”
A widely used reference in short-term insurance furthermore defines sum insured as, “a maximum amount payable by the underwriter in terms of a policy insuring loss or damage to property. It does not represent what will be paid, because what will be paid is limited by the cost of indemnity or reinstatement of damage, but it sets a ceiling on what can be paid (Nafte v Atlas Assurance Co Ltd (1924) Wld239)” (Lindstrom C. (2012), An encyclopaedic dictionary of short-term insurance and related terminology used in South Africa).
Basis of valuation
Most Plant All Risks underwriters offer three basis of valuation (sum insured) being, New Replacement Value (NRV), Agreed Value (AV), and Market Value (MV).
It is not our intention to indicate nor recommend what we believe is the best or most preferable basis for valuation, but to illustrate some of the differences between these valuations. The most important principle is that the policy is still a policy of indemnity, and it is drafted as such. Secondly, the sum insured is one of the most crucial factors to ensure adequate claims settlements.
Principle of indemnity
To illustrate the principle of indemnity, we must point out that in the event of a total loss, under all three basis of valuation, the settlement will be market value (with a small variation which may apply to agreed values), or the sum insured should it be less than the market value.
You may ask, why then the difference in valuations?
We trust that the following explanations on partial losses will answer the question. We also wish to highlight the differences in the application of the different clauses, should a partial loss occur:
New Replacement Value
Should new replacement parts, spares and components be required, no betterment will apply, but be wary of underinsurance. The sum insured must represent the new replacement value of the item. Should the item be insured for less than the present new value, average will apply to the claim.
Market Value
Should replacement parts, spares and components be required, the policy shall be limited to the proportion that the sum insured bears to the new replacement value of the item damaged.
Agreed Value
Agreed value relates to equipment which is custom or purpose-made or for which no general market is available. However, should the item be readily replaceable and market values are available, claims will be settled as stated above.
Importance of revaluing and adjusting sum insured
True indemnity will always relate to the actual cash value of the item at the time of the loss. Market value is normally calculated by deducting an amount based on the usage, age, and condition of the item. The sum insured (market value) is intended to allow for the replacement of the item with an item of a similar condition.
The pre-used plant market value is more than often also influenced by the construction and building market conditions asking for more mechanical support in an upswing in the economy. Secondhand equipment or even the unavailability of obtaining new equipment tends to have an upwards price effect of secondhand equipment.
It is important for owners of plant and equipment to regularly revalue their plant and adjust the sum insured accordingly. Like for most goods and services, inflation can also increase the cost of replacement and influence the cost of insurance. A small additional premium can make an enormous difference to a claim.