IRDAI’s website has just the below information about Salvage:
“In case of claims under various types of insurance policies, the partly damaged goods or the wreck of a car or any machinery or any other property settled on Total Loss Basis is known as “Salvage”. After settling the claim for the full amount, the salvage becomes the property of insurance company.”
While THE INSURANCE ACT, 1938 says nothing about Salvage.
And THE MARINE INSURANCE ACT, 1963 – RIGHTS OF INSURER ON PAYMENTS Section 79. Right of subrogation – reads as follows:
“(1) Where the insurer pays for a total loss, either of the whole, or in the case of goods of any apportionable part, of the subject-matter insured, he thereupon becomes entitled to take over the interest of the assured in whatever may remain of the subject-matter so paid for, and he is thereby subrogated to all the rights and remedies of the assured in and in respect of that subject-matter as from the time of the casualty causing the loss.”
The question therefore arises as to when did the client agree to hand over to the insurer the wreck of a car or any machinery or any other property once the claim is settled on Total Loss Basis? Nowhere in the proposal forms, nor in the policy conditions it is stated if “the client agrees to hand over the wreck of a car or any machinery or any other property once the claim is settled on Total Loss Basis”. This is what our present understanding of “Salvage” is.
The phrase “once the claim is settled on Total Loss Basis” shall mean once indemnity is paid. This brings us to the question what is Indemnity? How is Indemnity paid?
What is Indemnity?
Indemnity is compensation for loss or injury so that the affected person is placed in the same financial position as before the accident. He will be neither worse nor better off.
Insurable interest must be calculable in financial terms since this would represent the amount lost in the event of damage or loss. Obviously, one cannot put a value on one’s own life or limb and therefore these policies are not subject to the doctrine, but all motor, property and liability policies are.
How is Indemnity provided?
The simplest situation arises with liability policies where indemnity will be the amount of Court award, or settlement negotiated out of Court, plus legal costs, if any.
In the case of property losses, the majority of cases are dealt with by a cash payment. In other cases, the insurers may instruct repairs as in motor insurance, or replace goods as occasionally occurs with jewellery.
The Measurement of Indemnity
In a few cases, for example in motor insurance, there may be a ready second-hand market to establish value in the event of total loss. In all other cases, the measurement of indemnity for total loss is the cost of replacement less the value of any betterment. In the case of partial losses, indemnity is the cost of repair less betterment, if any.
For example, in a house fire, if it costs Rs. 20,000/- to replace a carpet which was two years old, one must ascertain the expected life-span of the carpet destroyed. If it was five years, then the carpet lost was 2/5ths worn and indemnity would be 3/5ths of Rs. 20,000/- that is Rs. 12,000/. The original cost of the carpet is immaterial.
Amendments to the Principle
Policies covering commercial and industrial buildings and machinery, and house policies can be extended to include reinstatement or new-for-old conditions, whereby the full cost of replacement will be paid, that is Rs. 20,000/ in the case of the carpet loss quoted earlier.
Another variation is where it would be difficult to establish value after loss. Examples are ships and their cargoes, or rare articles, and in these cases, their value is agreed at inception and the value paid in the event of total loss. Indemnity applies for partial losses.
Distinction between Indemnity and Insurer’s Liability
Ideally, the insurer’s liability will be the indemnity, but there are various ways in which the liability may be less than indemnity.
Excess or Deductible
Sometimes by choice or otherwise, the insured has to bear the Rs. x of each loss and in such cases, the insurer’s liability will be that amount less than indemnity. The value of x in any one case is determined by the circumstances. In private motor policies, there are specific amounts that an insured may select to earn as a discount in premium. In other cases, such as large fire policies held by industrial concerns, it will be a matter for negotiation.
The term excess is usually used for small amounts, for example Rs. 150, Rs. 250, Rs. 1000. Where the amount is larger, for example Rs. 2500, Rs. 10,000 or even Rs. 1 million, the term deductible is used.
Sum Insured/ Limit of Indemnity and Average
If the sum insured is less than the value lost, then the limit of the insurer’s liability is the sum insured. Where a limit of indemnity is written into the policy, that is the insurer’s maximum liability.
In the event of the sum insured being low, certain policies such as commercial fire and theft are subject to average whereby partial losses are reduced in the proportion of sum insured to full value.
The following formula is used to calculate the amount payable in a case of under insurance.
SUM INSURED X LOSS = SETTLEMENT
FULL VALUE
Gopal’s house is valued at Rs. 50,00, 000. He insures it for Rs. 40,00,000. After a few months he suffers a fire loss of Rs. 10,00,000. Will Gopal get Rs. 10,00,000?
NO. Gopal was underinsured. Then, how much will Gopal get?
S.I/F.I X LOSS = Rs. 40,00,000/Rs. 50,00,000 X Rs. 10,00,000= Rs. 8,00,000
For instance, if Kiran insured his house for Rs. 150,000 and four months later the house was totally destroyed by an earthquake. Kiran would not get more than Rs. 100,000 if the value of the house at the time of loss was Rs. 100,000. The purpose of indemnity is to prevent profiting from insurance and to reduce moral hazard.
The purpose of the average clause is to provide equity in rating and to allow an insurer to collect premiums which are commensurate with the risks insured.
Average condition generally relates to inadequacy of Sum Insured (S.I) and insured paid a lesser premium in relation to the risk he brought. There are different applications of Average condition. They are:
- Pro-rata condition of Average
- Special Condition of Average
- Two Conditions of Average
- 85% Condition of Average (Reinstatement Memorandum)
- First Loss
Pro-rata condition of Average
Pro-rata condition of Average is applied if the S.I. of a property insured, at the time of any loss, be less than the actual value at risk then the amount of claim will be proportionately reduced. The following formula is used:
S.I. / Actual value at risk * Loss
For example: Naveen owns a building valued Rs. 250,000. The building suffered a storm damage of Rs. 20,000. How much would Naveen get if the building was insured for Rs. 200,000 and the policy was subject to Rs. 200 Excess?
Answer: S.I. / Actual value * Loss
200,000 / 250,000 * 20,000 = Rs. 16,000
Amount payable 16,000 – 200 = Rs. 15,800/-
Consider another example:
Mohan owns a building valued Rs. 150,000. He insured it for Rs. 100,000. Several months later his building was totally destroyed in an earthquake. How much should Mohan get if the policy was subject to an excess of Rs 100?
Answer: This is a classic case of a total loss case. Hence, average condition will not be applied. Full S.I. would be payable – i.e., 100,000 – 100 = Rs. 99,900/-
Special Condition of Average
Special Condition of Average is applied to farming/ agricultural produce and when S.I. is less than 75% of the actual value. The reason for granting the insured this facility is that there are fluctuations in the prices of farming products.
For Example – a farm produce was insured for Rs.100,000. It suffered a loss of Rs.10,000 due to fire. The actual value of the commodity at the time of loss was Rs.120,000. How much should the insured get?
Answer: Let us check the 75% standard first i.e., 100,000 / 120,000 = 83%. Since it is not less than 75%, average will not be applied and the insured will get the full loss – Rs.10,000.
Consider another example – Work out the final claim amount to be paid to the insured in relation to the following farming product claims: S.I. Rs. 600; Value at risk Rs. 1000; Loss Rs. 300
Answer: Let us check the 75% standard first i.e., 600 / 1000 = 60%. Since the S.I. is less than 75% of the actual value, average will be applied. 600 / 1000 * 300 = Rs. 180
Two Conditions of Average
In order for this type of average to be applied, there must be two policies are to be in force; One of which covering more specific location and the second covers all locations on floating basis (with one S.I.).
How it is applied in settling a claim? The second policy (floating) will only be involved if the more specific policy is exhausted.
Let us take an example: Tariq is a merchant having two fire insurance policies. His 1st policy covers his stock at Abids store for Rs. 40,000 and this policy is subject to pro-rata average. His 2nd policy (on floating basis) covers his stock in Hyderabad and Secunderabad stores for Rs. 40,000. This policy is subject to the “Two Conditions of Average” clause.
A Fire damage at Abids store caused Rs. 2,000 worth of damage to the stock. At the time of loss each store had Rs. 50,000 worth of stock. If this is the situation, how is the loss apportioned between the policies?
Answer: Step 1:
The more specific policy pays first i.e., the policy which covers only Abids store. Average = SI / Value at risk * loss. = 40,000 /50,000 * 2,000 = Rs. 1,600
The remaining (2,000-1,600) Rs. 400 goes to the floating policy.
Step 2: The Floating policy. The formula for the two conditions of average is:
SI (of floating Policy) / Net Actual Value Protected * Remainder amount of loss
The Net actual V. protected = Actual Value for both stores (less) The SI for the first.
100,000 – 40,000 = Rs. 60,000.
Therefore, the amount payable by 2nd policy is: 40,000 / 60,000 * 400 = Rs. 267/-
The total amount payable is: 1,600 + 267 = Rs. 1,867/-. The insured has to bear the difference i.e., Rs. 133/-.
85% Condition of Average (Reinstatement Memorandum)
This is a policy condition to protect the interest of insurer by giving the insurer the right to reinstate rather than making cash settlement at the time of the claim. The insurer may choose to reinstate:
- When dealing with difficult insured (amount)
- If fire is suspicious
- If it is less expensive to reinstate
- If contribution arises
Thus, Reinstatement is an endorsement to original policy, requested by the insured at inception to give the insured the right to request reinstatement. The reinstatement must be carried out & that must be without delay or it may be carried on the same site or other site provided the liability of the insurer is not increased.
Reinstatement is a form of “new for old” used in case of building and machinery (not stocks). It is applied for partial and total losses and is subject to 85% condition of Average. Thus, the formula is:
S.I. /Reinstatement cost at the time of reinstatement * Loss = Settlement
For Example, A fire occurred at a factory and the loss adjuster obtained the following information:
- Value at risk at the time of the loss Rs. 8,40,000
- Loss on indemnity basis Rs. 1,05,000
- Reinstatement value at the time of the reinstatement Rs. 9,20,000
- Loss on reinstatement basis Rs. 1,14,000
- The Fire Policy with S.I. of Rs. 8,00,000 carries “Reinstatement Memorandum”.
Let us deal with the claim on an indemnity basis first. The formula is:
Sum Insured / Value * Loss = Settlement.
Rs. 8,00,000 / Rs. 8,40,000 * Rs. 1,05,000 = Rs. 1,00,000/-
Now let us deal with the loss on reinstatement basis.
The formula is: Sum Insured / Value * Loss = Settlement
Rs. 8,00,000 / Rs. 9,20,000 = 86.96%. Average will not apply
Therefore, claim on reinstatement basis is Rs. 114,000 and payable in full provided the insured elects to reinstate.
Consider another example – A fire occurred at a factory and the loss adjuster obtained the following information:
- Value at risk at the time of the loss Rs. 8,40,000
- Loss on indemnity basis Rs. 1,05,000
- Reinstatement value at the time of the reinstatement Rs. 9,60,000
- Loss on reinstatement basis Rs. 1,14,000
- The Fire Policy with S.I. of Rs. 8,00,000 carries a “Reinstatement Memorandum”
Let us deal with the claim on an indemnity basis first. The formula is:
Sum Insured / Value * Loss = Settlement.
Rs. 800,000 / Rs. 840,000 * Rs. 105,000 = Rs. 100,000
Now let us deal with the loss on reinstatement basis. The formula is:
Sum Insured / Value * Loss = Settlement
Rs. 8,00,000 / Rs. 9,60,000 = 83.33%. Therefore, Average will apply
83.33% * Rs. 1,14,000 = Rs. 95,000/-.
In this case, the insured is better off with indemnity basis
First Loss
First Loss – is normally used to insure Supermarkets and other similar risks against theft. The premium calculation is based on the declared value rather than the S.I. and then the premium is to be discounted. The application of average is based on the relationship between the actual value at risk at the time of loss and the declared value.
For Example: Ratna Deep Supermarket was insured with UIIC on First Loss basis. The S.I. was Rs. 2,00,000 and the declared value of goods was Rs. 5,00,000. The policy is subject to average and there was a deductible of Rs. 250. During the currency of the policy unknown persons broke into the Supermarket and stole goods valued at Rs. 6,000. The Loss Adjuster estimated the actual value of goods at the time of loss at Rs. 6,50,000. How much the insured is entitled to get and how the claims will be settled?
Average to be applied. Declared Value / Actual Value * Loss
5,00,000 / 6,50,000 * 6,000 = Rs. 4,615 – Rs. 250 = Rs. 4,365
Consider another example to understand First Loss policy. Midway Supermarket insured their stock with TATA AIG against theft under First Loss Policy. They informed the underwriter that the actual value of the stock is Rs. 10,00,000 and the maximum amount that could be stolen in any one incident is Rs. 2,00,000.
- The rate applied to this type of risk is 3%₀ (per mille).
- TATA AIG grants 10% discount for those insuring their stock under first loss policy.
- The policy is subject to Rs. 250 deductible.
Five months after the outset of the policy a theft incident took place. Stock of Rs. 15,000 were stolen. The claim surveyor estimates the actual value of stock at Rs. 17,00,000. Based on this information:
1. Calculate the insurance premium paid by Midway Supermarket.
2. How much the insured is going to get for his claim?
Premium Calculation – Declared value * Rate = 10,00,000 * 3/1000 = 3,000
TATA AIG grants 10% discount = 3,000 * 10% = 300
Final premium paid = 3,000 – 300 = Rs. 2,700/-
Claim Calculation – Since the declared value of stock is less than the actual value, average is to be applied.
Declared Value / Actual Value * Loss = 1,000,000 / 1,700,000 * 15,000 = Rs. 8,824
Final amount payable = 8,824 – 250(deductible) = Rs. 8574
“Generally, the job of salvage disposal is entrusted by the insurance company to the surveyor who carried out the loss assessment, subject to observance of procedure for salvage disposal. The amount realized through salvage disposal will be set off by insurer against losses paid by them.”
What you see and read above is practice. The existing understanding is that both the Regulator and the insurers have considered Salvage as something to be disposed of to reduce the losses of the insurer. The Law, Regulator and the insurer could not think of any other use for Salvage except the above mentioned. This very thought has made insurance selfish and self-centred.
There is a legal maxim attributed to the renowned 18th-century English jurist William Blackstone which reads: “It is better that ten guilty persons escape than that one innocent suffer.” This legal maxim and therefore the law gives maximum importance to the innocent rather than the guilty. In case of insurance, exactly opposite is the case. We give more importance to reducing insurers losses than making the society a safer place to live. This unfathomable gap is costing insurance much more than the losses paid.
No sir! A contract of insurance does not end with the payment of claim. Yes. We are following the law in letter by settling the claim, but violating it in spirit. The spirit of law is honored when the insurer voluntarily takes a step further, make meaningful use of salvage. Meaningful use of salvage is, for instance, to use the salvage to educate the society and to prevent future accidents and loss of lives and property. This is the gap our Insurance Salvage Patent aims to fill; to make the world a better place to live.
When I run over libraries, persuaded of the principles of Indemnity and Salvage, what havoc must I make? If I take in my hand any volume of insurance or the decided case laws for instance, allow me to ask, does it contain any information of definition of Indemnity and Salvage? No. Does it contain any explanation giving reasoning concerning Indemnity and Salvage? No. Commit it then to the flames: for it can contain nothing but sophistry and illusion!
Authored by:
Dr. K. Rajagopal Reddy
PhD, FII, FCII (UK), FLMI (US), FT
Chartered Insurance Practitioner
Topspot Insurance Broking Pvt. Ltd
