What is Reinstatement Value Clause in a Fire Insurance Policy?

Reinstatement Value Clause in Fire Insurance Policy is a method of insuring assets at their Reinstatement Cost or Replacement Cost rather than their Depreciated Value in a Fire Insurance Policy.

There are 2 methods of declaring Sum Insured under a Standard Fire and Special Perils Insurance Policy:

1. Reinstatement Value Method: Under the Reinstatement Value Method, the Insured declares the Sum Insured of the Asset based on their Replacement Cost, that is the Value without deducting Depreciation. Since the Fire Insurance Policy replaces the old machinery with new machinery, it is also known as “New for Old Clause”.
2. Market Value Method: Under the Market Value Method, the Insured declares the Sum Insured of the Asset based on their Market Value after deducting depreciation.

The Reinstatement Value Clause in a Fire Insurance Policy reads as follows:

“Reinstatement Value Insurance may be granted on Buildings, Machinery Furniture, Fixture and Fittings only subject to the incorporation of the following memorandum in the Policy:                     

It is hereby declared and agreed that in the event of the property insured under the Policy being destroyed or damaged, the basis upon which the amount payable under the Policy is to be calculated, shall be cost of replacing or reinstating on the same site or any other site with property of the same kind or type but not superior to or more extensive than the insured property when new as on date of the loss, subject to the following Special Provisions and subject also to the Terms and Conditions of the policy except in so far as the same may be varied hereby.”

Special Provisions under the Reinstatement Value Clause

1. The work of Replacement or Reinstatement (Which may be carried out upon another site and in any manner suitable to the requirements of the insured subject to the liability of the Company not being thereby increased)  must be commenced and carried out with reasonable dispatch and in any case must be completed within 12 months after the destruction or damage or within such further time as the company may in writing allow, otherwise no payment beyond the amount which would have been payable under the policy if this memorandum had not been incorporated therein shall be made.
2. Until expenditure has been incurred by the Insured in Replacing or Reinstating the property destroyed or damaged the Company shall not be liable for any payment in excess of the amount which would have been payable under the Policy if this memorandum had not been incorporated therein.
3. If at the time of Replacement or Reinstatement, the Sum representing the cost which would have been incurred in Replacement or Reinstatement if the whole of the property covered had been destroyed, exceeds the Sum Insured thereon or at the commencement of any destruction or damage to such property by any of the perils insured against by the policy, then the Insured shall be considered as being his own insurer for the excess and shall bear a rateable proportion of the loss accordingly.  Each item of the policy (if more than one) to which this memorandum applies shall be separately subject to the foregoing provision.
4. This Memorandum shall be without force or effect if:

1. 1. the Insured fails to intimate to the Company within 6 months from the day of Destruction or Damage or such further time as the Company may in writing allow his intention to replace or reinstate the property destroyed or damaged.
   2. The Insured is unable to unwilling to replace or reinstate the property destroyed or damaged on the same or another site.

How does the Replacement Value Clause in a Fire Insurance Policy Work?

The Insured under a Fire Insurance Policy declares the Sum Insured under a Fire Insurance Policy on reinstatement basis or replacement basis, that is, how much it costs to replace the insured asset with a new asset. In declaring the Sum Insured, the Insured does not deduct Depreciation while declaring the Sum Insured of the asset.

This helps in case of an Insurance Claim because the Fire Insurance Policy will pay the replacement cost of the asset rather than depreciated value. This is extremely important because most fixed assets would have a huge depreciation in value over the years. If the Insurance Policy only paid the depreciated value, then the Insured would have to bear a major cost in replacing the damaged asset out of his own pocket in case of a Claim.

Thus, Reinstatement Value Clause is a very important feature of a Fire Insurance Policy.

Example of a Fire Insurance Claim under the Reinstatement Value Clause in a Fire Insurance Policy

The working of a Reinstatement Value Clause in Insurance can be better explained with the help of an example:

Consider that the Insured has insured plant and machinery of his factory at a Reinstatement Value of Rs5 Crores. Over the next 5 years, the value of the Plant and Machinery has depreciated to Rs2 Crores.

If there is a Fire Insurance Claim in the 5th Year, the Policy would pay the Reinstatement Value of Rs5 Crores even though the current depreciated value is Rs2 Crores only. This is because the Policyholder has insured the assets at the Reinstatement Value of Rs5 Crores 

If the assets were Insured at Market Value, then the Fire Insurance Policy would have paid only the market value of assets of Rs2 Crores.

What assets can be insured with a Reinstatement Clause?

Only fixed assets such as plant and Machinery, Buildings, Furniture, Fixture and Fittings etc can be insured with a Reinstatement Value Clause in a Fire Insurance Policy. 

Things to Remember when Insuring Assets under the Reinstatement Value Clause

The important points to remember under the Reinstatement Value Clause are as follows:

The Reinstatement Value Clause is subject to the Principle of Indemnity where the Insured can replace the damaged machinery and assets with a new asset of the same type and specifications. The Policy will not pay the cost to purchase a better asset.

The Policyholder has to declare the Sum Insured at Reinstatement Value or Replacement Cost when Insuring the Asset. If the Sum Insured is found to be lower than the Reinstatement Cost, the Fire Insurance Claim will be subject to Underinsurance and the Policyholder will have to bear a rateable portion of the loss. Since, the Asset Value normally tend to increase due to Inflation, the Policyholder will have to review the Insurance Policy on a periodic basis to check for the adequacy of Sum Insured.

The Insured has to replace the insured assets to get compensated at Reinstatement Cost in case of a Claim. If the insured does not replace the asset, then the Insurance Policy will reimburse him as per the market value that is pay him the cost after deducting depreciated value. Another important point to remember is that the Reinstatement must be commenced within a reasonable time period, and it should be also completed within 12 months of damage, unless the Insurance Company specifies otherwise.

Conclusion

Reinstatement Value Clause is an important feature of a Fire Insurance Policy which affects the Claim Settlement Amount. It is important for Policyholders to understand the same.

If you have any questions regarding Insurance, you can ask our Expert by mailing at insurance@qian.co.in or call us on 022-22044989.

We would be glad to assist you.

Source: All India Fire Tariff