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Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection from an insurance company against any potential losses resulting from the damage or destruction of the insured asset. When insuring physical assets such as buildings, plant, machinery, equipment, vehicles, furniture, fixtures, etc., it is imperative that the assets are insured at an appropriate value – derived through a professional Insurance Valuation process. The idea is to ensure that the asset owner is able to continue with the operations relating to the damaged asset through the financial reimbursement provided by the insurance company. Use of general estimates like original cost of the asset or its current market value or any other unprofessional methods to estimate the value of assets for insurance purposes can often result in either:
a) Insufficient Coverage – which means the financial reimbursement provided by the insurance company will not be sufficient for the asset owner to repair or replace the damaged assets in a way that ensures business continuity; or
b) Over Insurance – which means the asset owner is paying excessive premiums to the insurance company due to assigning a much higher value to the assets than what is really required.
A valuation done specifically for insurance purposes specifies the proper basis of indemnification when an asset is damaged or destroyed, and follows a methodology that is most suited for the specific industry and assets under consideration. The commonly used approaches for insurance valuation are:
- Reinstatement or Replacement Value
Cost necessary to replace, repair or rebuild the insured asset to a condition substantially the same as but not better or more extensive than its condition when new.
- Indemnity Value
When an asset can be repaired – then this is the cost necessary to restore the asset to a condition substantially the same as, but not better or more extensive than, its condition at the time of loss, taking into consideration age, condition and remaining useful life of the asset.
When an asset is totally destroyed or cannot be repaired – then the Indemnity Value will be the Market Value of the asset at the time of damage.
The Reinstatement or Replacement Value approach is generally considered to be the most reliable approach for Insurance Valuations, especially for specialized assets such as complex plant and machinery, large or bespoke buildings etc. where in case of damage or destruction, specialized knowledge is required to understand what it would take for the asset to start functioning in the same way it was prior to the damage. The Indemnity Value approach is gradually getting less utilized and only deployed under certain simple cases. An example would be a stolen or totally destroyed car, which is an asset that has a very standard and ready secondary market – and hence the Market Value of the car at the time of insurance would be an appropriate value for the asset owner to receive from the insurance company to enable him or her to purchase a similar car.
Key Advantages of Professional Insurance Valuation Assessment:
- Correct Coverage: Ensures the correct level of coverage, so that you are adequately protected in the event of loss or damage, and the full amount of a claim up to the policy limits can be expected, with no out of pocket funds required due to inadequate valuation. At the same time, it ensures that you are not overpaying the insurance company for a premium that is based on a value that is excessive to the requirements.
- Itemised Record: A professional insurance valuation report provides a detailed and thorough item-wise record of the nature and specifications of all major and minor assets – which is of extra importance when complex real estate, plant and machinery are involved. Hence, in the event of a partial loss or damage, the relevant assets are easily identified and claims can be properly substantiated. This is even more important when a facility has been expanded over the years. Conversely, if companies have their assets insured based on a high level estimate of the value of the broad asset classes, they will struggle to identify and get an adequate settlement from their insurance company when just some of the assets have been affected.
- Speedy Settlements: Accurate insurance valuations often enable a simple and quick negotiation process with insurance companies and loss adjusters, therefore speeding up the settlement of a claim.
- Adequate Inclusions & Exclusions: An insurance valuation assessment facilitates noting of adequate inclusions and exclusions which will be unique to that insurance policy, resulting in a more accurate value and a clearer drafting of the insurance policy.
- Useful for Other Purposes: The data gathered for the verification, condition and value of assets during an Insurance Valuation exercise can be useful for certain other purposes also, e.g. appraisal for secured finance, mergers and acquisitions, Fair Value for IFRS, etc. At times it can also be helpful in providing evidence for tax purposes to establish the amount of an uninsured loss.
Important things to look out for to ensure accurate Insurance Valuation:
- Qualified Firm: To carry out the insurance valuation, use a professional and qualified firm which is certified and regulated by a reputable international authority, such as RICS (Royal Institution of Chartered Surveyors). The firm must have a qualified team that has insurance valuation expertise across all asset classes i.e. real estate, plant & machinery, heavy equipment, vehicles, furniture, fixtures, IT assets, etc.
- Frequency of Exercise: The Insurance Valuation exercise should ideally be carried out annually. As a bare minimum it should be done every 3 years, with an annual reassessment to take into account aspects such as inflation, alterations, legislation changes, obsolescence etc., to determine whether a full exercise is required or not.
- Inflation: It is important to remember that in some cases a loss could happen on the final day of your insurance period and reinstatement may not be completed until several years thereafter. Hence, depending on the nature of the assets, it would be prudent to include a suitable inflation provision in the insurance policy so that the insurer will cover up to that amount.
- Inadvertent Omission of Crucial Items: A common mistake when considering the total rebuild of assets such as buildings and production facilities is to exclude some crucial aspects of reinstatement. Typical examples include: cost of debris removal, professional fees for rebuilding, cost of foundations, requirements of public authorities, Green upgrades and Value Added Tax.
- Obsolescence: In some circumstances where full reinstatement is required, the insured entity may require a different type of asset due to the potential obsolescence of the existing asset. This is specially common when the assets involve advanced technology, and hence it would be important to assess what type of replacement is being considered for insurance valuation purposes. In some cases, the functionality of certain assets can easily be delivered by a new technology that is cheaper and more efficient, in which case the insurance value for that asset will be of a smaller amount, resulting in reduced insurance premium.
Insurance Valuation is therefore a wise precaution that firms and individuals should certainly undertake. It is especially necessary in circumstances where:
- Assets, especially machinery, are old
- The firm is old and may have been indexing their figures up on a yearly basis assuming that this will cover any increase in new equipment cost prices or specialized bespoke equipment.
- Current valuations are several years out of date
- There is a significant reliance on foreign machinery
- A business has undertaken significant restructuring, investment or expansion in stages
- Projects have encountered cost overruns
- A sudden and usually temporary change has occurred in the cost of materials, services and labor due to a change in their demand following a catastrophe like natural calamity (tornado, hurricane, earthquake etc.) or a pandemic such as COVID-19
- Business Interruption studies are required, which is another important factor of an insurance policy
All in all, the benefits of carrying out a proper Insurance Valuation far outweigh the additional costs that may be involved in hiring a professional valuation firm. A company must look at the long term advantages in order to secure its operations. It is no surprise that several countries such as Saudi Arabia have made it mandatory to have a proper Insurance Valuation exercise done by an independent and certified firm before any assets are insured.