The machine was bought in 2014. Original Purchase Price: Rs 1 crore.
The cost of the same machine in 2024 (Reinstatement Value) will be Rs 3 crores.
Let’s assume the Sum Insured = Rs 1 crore. (Insured on Original Purchase Price).

Let’s assume the life of the machine is 20 years. Since 10 years are completed – depreciation will be 50%. (we are not complicating the example by talking about technical depreciation, which could be different).
Let us assume one major part of the machine, costing today Rs 50 lakhs is damaged and needs to be replaced.

Let us assume that Salvage is nil and Excess is also nil. Let us assume that the policy is on Market-Value Basis.
Assessed Loss = Rs 50 lakhs
Depreciation = 50% = Rs 25 lakhs
Assessed loss after Depreciation = Rs 25 lakhs
Value at risk: 3 cores less 50% depreciation = Rs 1.5 crores.
Loss Payable after application of Under Insurance = 25 lakhs * Sum Insured/Value at risk = 25 lakhs * 1/1.5 = Rs 16.67 lakhs.

If the insured had selected a reinstatement value basis and insured adequately (i.e. Rs 3 cores), he would have gone full Rs 50 lakhs as a claim. However, due to choosing market value and not insuring adequately, the insured is only getting one-third of the claim ie Rs 16.67 lakhs.

Please write in the comment box if the insured selected RIV basis, however, the sum insured was the original purchase price, what is the amount of claim the insured would have gotten?

~Blog by Atmaram Cheruvu