Chapter 7: Indemnity

Question 1

Define indemnity

Answer 1

Financial compensation sufficient to return the insured to the same financial position they were in before the loss occurred

Question 2

What tort case established the importance of the principle of indemnity?

Answer 2

Castellain v. Preston (1883)

Question 3

What kind of policies are exempt from the principle of indemnity?

Answer 3

Benefit policies - these instead provide a fixed agreed amount. Used when you cannot place a financial value on the loss, usually for health and sickness related policies

Question 4

What four settlement options are available to insurers?

Answer 4

1. Cash payment
2. Repair
3. Replacement
4. Reinstatement

Question 5

What is cash payment?

Answer 5

Payment of money by the insurer to the insured

Question 6

You claim for a tv which if you purchased retail would cost you £2000 to replace. The insurer has a relationship with a retailer and has bulk purchasing power, so can purchase it for £1,600. You reject the offer of a replacement TV and ask for a cash payment. How much will you receive?

Answer 6

£1600

Question 7

What is repair?

Answer 7

The insurer will pay to have the property repaired, often for a discounted rate at an “approved” or “recommended” repair shop. The insurer will directly pay the repairer rather than the insured

Question 8

Why would an insurer have approved or recommended retailers?

Answer 8

They can guarantee quality of workmanship and may be able to negotiate discounted rates to lower costs

Question 9

What is replacement?

Answer 9

The loss is replaced - for example broken glass or damaged property

Question 10

What is reinstatement?

Answer 10

The insurer agrees to return the property to the state it was in before loss occurs

Question 11

What is the difference between reinstatement and repair?

Answer 11

Reinstatement usually only applies to buildings and sometimes complex machinery. The insurer takes occupation of the property, whereas repair does not have this or the same degree of project management. Reinstatement is not a popular option with insurers whereas repair is common, especially in motor

Question 12

In property insurance where the subject matter is completely destroyed (total loss), what is the measure of indemnity?

Answer 12

The replacement cost of the property, minus an allowance for wear and tear

Question 13

In property insurance where the subject matter is only partially damaged, what is the measure of indemnity?

Answer 13

Repair cost, minus an allowance for wear and tear

Question 14

In liability insurance what is the measure of indemnity?

Answer 14

The cost required to cover the insured’s legal liability to pay damages and costs. Varies so not set by the policy, and often decided by the courts. Limited to a maximum amount set out in the policy

Question 15

What is an agreed value policy?

Answer 15

The insured value is agreed at inception by the insurer and insured. Also called a valued policy. The insurer will pay the agreed amount in the event of total loss with no allowance for wear and tear or change in value (either up or down)

Question 16

How is indemnity measured in marine insurance?

Assuming not an agreed value policy

Answer 16

Calculated using the formula in the Marine Insurance Act 1906

Question 17

What are the two measures of indemnity for property insurance? Define both (please)

Answer 17

Indemnity settlement/Basic cover - The cost of repair or reconstruction at the time of the loss, less an allowance for any improvements resulting from the repair or reconstruction (called betterment)

Reinstatement conditions - Does not take into account wear and tear, but is instead based on the total cost of reinstatement at the time of reinstatement. Can occur in different ways

Question 18

What are a reinstatement memorandum and a day one reinstatement types of and what is the difference?

Answer 18

Reinstatement conditions to provide indemnity, usually for property or machinery

Reinstatement memorandum: The sum insured represents the full value at the time of reinstatement. The premium is based upon this amount. The insured value must be at least 85% of the actual value otherwise the claim is reduced. This gives a 15% margin for error when estimating the value at time of reinstatement. EG a building cost £1 million to purchase but it is estimated it would cost £1.4 million to rebuild so is insured based on this amount

Day one reinstatement: The reinstatement amount is stated on the first day of the policy. The insurer automatically applies inflation to this amount (usually 50%) but applies a smaller premium increase (usually 15%). There is no margin for error like with reinstatement memorandum

Question 19

What is new for old cover?

Answer 19

Replaces property, usually household goods, with brand new replacements with no allowance made for wear and tear. Sets the sum insures to the full replacement cost of the property and reflected in a higher premium

Question 20

What is the measure of indemnity for basic machinery cover?

That is not under reinstatement condition, which is more common for machinery

Answer 20

If a second hand market exists it is the cost of purchase, transport and installation

If no second hand market it is the cost of repair or replacement less wear and tear

Question 21

What is the only kind of property where the insured is entitled to receive potential sale profit?

Answer 21

Farming stock eg livestock and produce

Question 22

What are 3 common ways the principle of indemnity can be modified?

Answer 22

1. Agreed value policies
2. New for old cover
3. First loss policies

Question 23

What is a first loss policy?

Answer 23

When the insured believes total loss seems impossible so they only seek insurance up to a certain amount less than the full value
(Insurer agrees not to subject the policy to average)

Question 24

What does the Enterprise Act 2016 do?

Answer 24

Gives policyholders a legal right to claim damages in the event of late payment of their claim. Sums due to the insured must be paid within “a reasonable time”

Question 25

What are the 4 limiting factors where an insurer may provide less than full indemnity?

Answer 25

1. Sum Insured
2. Average
3. Deductible
4. Excess

Question 26

What does it mean if a policy is subject to average?

Answer 26

The policy underinsures the subject matter and the sum insured does not cover the total value. Any claim is reduced by the same pro rata proportion

Question 27

You have contents insurance with a sum insured of £10,000 which is subject to average. You make a £1200 claim and it is determined that the actual value of your contents totalled £15,000. How much will you receive from your claim?

Answer 27

£800

Question 28

Define excess

Answer 28

An amount deducted from each claim and is paid by the insured

Question 29

Define deductible
(The historical definition, there is lack of consistency in the market today)

Answer 29

A large excess - usually in commercial policies

Question 30

Why might a policyholder want a voluntary excess?

Answer 30

They may be offered lower premiums as the insurer would not have to deal with losses below the excess and would have smaller payouts for claims over the excess

Question 31

How is the indemnity value of a manufacturer’s stock calculated?

Answer 31

The cost of raw materials at the time and place of the loss, plus labour and costs in respect of work in progress and finished stock

Question 32

How is the indemnity value of a retailer’s stock calculated?

Answer 32

The cost of replacing the stock at the time of the loss, plus cost of transport

Question 33

What is an inner limit? Give an example

Answer 33

A limit within the sum insured for specified items or categories. For example a limit on the value of jewellery within a household contents policy

Question 34

What is the special condition of average and when does it apply?

Answer 34

Applies to agricultural produce and livestock. As the measure of indemnity is the local market price at the time of the loss, the price may fluctuate significantly. Therefore if the value at time of loss is within 75% of the sum insured, average will not be applied