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January 2, 2012

Part of File Notes for CPD Lecture Series given by Alan FitzGerald on Reinstatement Memorandum and ‘Day 1 basis’

General file notes in the context of CPD Presentation given by Alan FitzGerald to a number of Insurers and Brokers from October 2011 to May 2012.

Reinstatement Memorandum –v- Indemnity 02 Jan 2012
A. FitzGerald, FCII., FCILA.
1920’s representations from British Industry (Textile and Metal) that normal material damage claims settlements, deductions for wear and tear dictated that companies had not enough money available to make up the difference between traditional indemnity valuation and the cost of replacing machinery.

The insurance industry responded with Reinstatement Memorandum which makes the Policy a Valued Policy in that it defines the basis of value for indemnity, no different from Marine Valued Policies.

Following initial scepticism that the Insured was only paid an indemnity figure greater than the traditional calculation of reinstatement less deductions for wear and tear, the Reinstatement Memorandum became well established for buildings and plant and machinery.

There is specific procedures to be followed which if not complied with dictates that “no payment beyond the amount which would have been payable in the absence of this Memorandum shall be made”.

Therefore the contract does not “revert” to indemnity, it simply “reverts” to the form of indemnity that would be within the basic Policy cover i.e. the Insurer agrees to pay the value of the property at the time of the happening of its destruction or the amount of such damage.

In accordance with Keystone Properties Ltd. –v- Sun Alliance (1992), value does not mean market value and Carrick Furniture Ltd. –v- General Accident (1978) – “to construe the word value as market value in the Insurer’s favour would violate the principle that documents such as this are to be construed contra proferentum” – conclusion, market value was not the appropriate basis of valuation for indemnity in that case.

Under Reinstatement Memorandum definition of “reinstatement” means
“repair or restoration of the property damage”
“rebuilding or replacement of the property lost or destroyed and which may be carried out in a manner suitable to requirements of the Insured or upon another site”.

To counter building inflation etc., Insurers agree to accept a measure of under-insurance before penalising the Insured – average will not apply if under-insurance is less than 15%.

“Until the cost of reinstatement has actually been incurred” – the Insured can only recover the amount which would have been available had the Memo not been a condition of the Policy. The Insured can therefore call for a payment of an indemnity other than Reinstatement Memorandum (see Keystone and Carrick).

Example – old building. If “traditional” indemnity is calculated deduction of 50% for wear and tear in order to establish the indemnity (CILA – R.M. Wamsley page 181, the principle of indemnity and its application).

“The Reinstatement Difference” – an initial payment based on “traditional indemnity” calculation.

Note interim payments are envisaged under a Business Interruption Policy (reference to payment on account being repaid if terms and conditions have not been complied with). No such comparable provision under Material Damage wording (ABI).

“Actually Incurred” – Contract signed with builder, the Insured legally liable for the cost, this cost is “incurred”.

Actually incurred infers that money has been paid.

Wamsley suggests that a “traditional indemnity payment would be greater than the amount otherwise coverable under the Reinstatement Memorandum because of possible application of average.

Reinstatement Memorandum (Day 1 basis)

Intention to mitigate problem of under-insurance as an alternative to 15% leeway under Reinstatement Memorandum.

ABI recommended wording.

Declared value shown in brackets, premium having been calculated accordingly.

Special Conditions – Reinstatement to commence without delay – cost of reinstatement to be incurred.

2 vital components

(a) Value of property day 1 i.e. when Policy was incepted or renewed).

(b) The selection of a possible rate of inflation in the period after day 1 to allow for the period of insurance and possible maximum period for reinstatement.

If the declared value is correct then there will be no deduction for under-insurance.

However if the declared value is inadequate then “Average” will apply.

Declared value for day 1 as given by the Insured
____________________________________________ x loss sustained
Actual value on day 1 x loss sustained.

Declared value means the Insured’s assessment of the cost of reinstatement at level of costs supplying at the inception of the period of insurance (ignoring inflationary factors) together with due allowance for Public Authority requirements, professional fees and debris removal costs.

Public Authority Requirements – impossible to establish with any certainty – arbitrary amount therefore has to be included.

Fees – 10%.

Debris removal – subjective decision.

In the event of a claim, it is necessary to establish that the declared value as defined was correct – no problem with buildings aspect i.e. bricks and mortar. Element of subjectivity for Public Authority requirements, fees and debris removal, therefore there is a margin of error within the declared value.

“Inflation Proofing” aspect is dealt with by Insured deciding what inflation will be from inception/renewal through the period of insurance and through possible time it takes to rebuild or replace the physical property.

Having established this percentage, it is applied to the declared value to become the limit of liability/sum insured.

For example it may be necessary to apply an inflation percentage of 20% to cover a period of say three years given the nature of construction.

Possibility property is destroyed on last day of period of insurance so this has to be considered.

What happens if 20% inflation cover was purchased at day 1 and 22% was required in the context of the actual inflation. The Insured still recovers up to sum insured but if costs exceed the declared value, no under-insurance applies and the Insured has simply run out of insurance cover for the difference of 2% on the rate of inflation.

Note average applies if declared value is less than cost of reinstatement at the inception of the period of insurance then liability for the damage shall not exceed that proportion which the declared value bears to the cost of reinstatement.

If claims are paid as if memorandum had not been incorporated (i.e. indemnity basis), the sum insured is limited to a percentage of the declared value. Therefore the declared value and sum insured are not the same thing. The percentage to be applied as a limit is an underwriting matter.

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