Conceptualization of Indemnity under Fire Insurance in English Business by BS Murthy books and stories PDF | Conceptualization of Indemnity under Fire Insurance

Conceptualization of Indemnity under Fire Insurance

There occurred a fire mishap in the farmhouse belonging to a gentleman of leisure, which in due course engulfed the neighborhood nursery. Among the properties destroyed in the fire or damaged during the fire-fighting operations were a large number of garden plants, in both premises, which have been insured, coincidentally, with the same underwriting office. For uniformity in loss analysis and equanimity in assessment, the underwriters chose to entrust the survey assignments of both the claims to a single surveyor.

Whereas the loss assessment with regard to the other damaged properties should pose no problem, as there are precepts and precedents to follow, the question of providing indemnity in respect of plants, to the respective insured’s, calls for a deeper contemplation on part of the surveyor concerned.

The fire policy unequivocally states that…….. “the company will pay to the insured, the value of the property at the time of the happening of its destruction or the amount of such damage, or at its option reinstate or replace such property or part thereof.”

What, in effect, is value? It is as per the Concise Oxford Dictionary, the ability of a thing to serve a purpose or cause an effect. What, then, is the value of the damaged plant to the respective insured’s?

To the landlord of the farmhouse, their value lies in the aesthetics they provide to the environs and the emotional feeling he derives from gardening them. However, to the nursery owner, the plants have an altogether different value, primarily mundane, in that they are the means by which he and his family get their livelihood from, through their sale, though he too may exult in their joyous presence. Thus, the value of the plants, property of similar nature, going by their ability to serve a purpose or cause an effect, is uniquely different to their respective owners.

If one were to arrive at the amount of compensation, a cost of production mode, it would involve the cost of planting nascent seedlings or saplings, of the same or similar varieties, of the damaged plants, capping it up with an allowance for such of the expenses on gardening, like the cost of manure and watering charges, that have to be incurred, till they would have grown into plants of the destroyed description as at the time of the outbreak of fire.

For the landlord, after he, in due course, psychologically overcomes his gloom, these seedlings and saplings, progressively create agreeable scenery, though different from the previous one, that too enlivens his environs, and thus would under the circumstances, apparently restore to him the value the damaged property hold for him. Thus the amount of compensation based on cost of production mode could fairly indemnify him for his material loss.

But, will it to the so for the nursery owner? Apparently, not so; assuming that the damaged plants range in their size, from one to three feet, as governed by their age from say, one or three months feet, as governed by their age from, say, one or three months, the replaced seedlings and saplings do not provide indemnity to him as they have no immediate value for him, in that they are not saleable at that time. They would start acquiring the lost value, as far as he is concerned, only after they grow up to the same or similar sizes and shapes, as at the time of the destruction of the existing ones, when only he would be able to resume the trade for his livelihood, which would be at a future date. Thus the cost of production mode of indemnity that arguably indemnifies the said landlord fails to pay to the insured, the nursery owner, the value of the property as it was at the time of happening of its destruction contrary to the letter and spirit of the policy.

What, then, represents true indemnity? Obviously it differs. To the nursery owner, it would appear logical, the payment of the saleable value of the damaged plants only can provide true indemnity, as their intrinsic value to him was the profit he would have normally realized from their sale, if not for the unfortunate intervention of the fire mishap, at that point of time. Any mode of compensation that does not take this reality into account, which thus falls short of value compensation, would tantamount to the travesty of indemnity. For the landlord, however, whose only interest lies in gardening, the damaged plants do not hold any commercial value, and if the compensation were to be on sale price, it would amount to enriching him to the extent of the profit margin, which does not represent his value in them. This would, thus, negate this spirit of indemnity, which seeks to deny the insured from making fortune out of his misfortune.

Lest someone would take exception to this train of reasoning on the specious plea that what is logical need not necessarily be lawful, let us consider the situation in the techno-legal angle as well. As is well known, insurable interest of the insured in the subject matter of insurance is an overriding consideration of the contract of insurance. What after all, is insurable interest? Lawrance J, in Lucena V. Crafurd Case (1806), defined insurable interest as – “to be interested in the preservation of a thing, is to be so circumstanced, with respect to it, as to have benefit from its existence and prejudice from its destruction. The property of a thing and the interest devisable from it may be very different, of the first, the price is generally the measure, but by interest in a thing every benefit and advantage arising out of or depending on such thing may be considered as being contemplated.”

Though the property of a thing, plants in this case, is the same for both the insured, the interest devisable from it, however, varies for both on account of differing benefits obtained and advantages derived from it before their destruction. Since insurable interest is the cornerstone of the contract of insurance, the foundations on which it is raised cannot be undermined while seeking to arrive at indemnity under the very contract, the raison d'être for the insured to enter into it, in the first place.

Further, the established case law on insurance emphasizes that the insured be placed in the same position prior to the loss in respect of the damaged property as his interest in it would have entailed him to at the point of loss. This proposition would also endorse the differential indemnity advocated in the seemingly apparent property damage involving the insured – the landlord and the nursery owner - having varied interests in their respective plants, the property of the same nature.

The all important principle of indemnity was categorically defined in the authoritative judgment of Brett. L. J in the celebrated case of Castellain V. Preston thus – “the very foundation, in my opinion, of every rule which has been applied to insurance law is this, namely that the contract of insurance contained in a marine or fire policy is a contract of indemnity and the indemnity only, and that this contract means that the insured, in case of loss against which the policy has been made, shall be fully indemnified. This is the fundamental principle of insurance and if ever, a proposition is brought forward which is at variance with it, that is to say, which either will prevent the insured from obtaining a full indemnity or which will give the insured more than a full indemnity, that proposition must certainly be wrong.”

From the principles of insurance, as discussed above, three fundamental characteristics emerge, and they are:-

i) That the indemnity should be based on the value the damaged property holds to the insured.

ii) That the interest devisable to the insured from the damaged property should not be lost sight of and he should be placed in the same position prior to the loss as his interest in it would have entailed him to at the point of loss and

iii) That the insured, in case of loss against which the policy has been made shall be fully indemnified and shall never be more than fully indemnified.

Though the mode of indemnity, by and large, is a settled issue in case of a variety of loss situations, it is not so in respect of los of finished goods in the manufacturer’s premises as there are two schools of thought governing the same - one that advocates the compensation on the basis of cost of production and the other that favours indemnity on the sale price. The protagonists of the former approach contend that since the insured is the manufacturer, he can produce similar goods to replace those destroyed, and thus can be deemed as fully indemnified by payment based on the cost of production. However, the antagonists to this approach aver that cost of production is merely the sum total of the cost of input materials plus labour and certain overhead charges, whereas the finished article is an independent marketable commodity with a distinct value of its own in the market place, governed by supply and demand, and therefore the indemnity should be based on the selling price.

Let us subject the proposition of compensation on the basis of cost of production to the twin tests of value and interest concepts of indemnity under the fire policy. As with the nursery owner, the value the damaged finished goods hold for the manufacturer lies in their ability to serve the sustenance of the enterprise through realization of profit margin from sale in the market place. The insurers, states the policy, will pay to the insured the value of the property at the time of the happening of its destruction; and value is nothing but the ability of a thing to serve a purpose or cause an effect. As the cost of production does not amount to the value of the damaged goods as far as the manufacturer is concerned, restricting the liability to the former goes against the grain of indemnity under the policy. Further, cost price compensation causes an effect, i.e. loss of accrued or anticipated profit to the manufacture in proportion to the inbuilt margin.

The same picture emerges when one goes by another cardinal principle of insurance, i.e. the insured be placed in the same position prior to the loss as his interest in it would have entailed him to at the point of loss. What, after all, is the interest of the manufacturer in his finished products but to sell them in the market place, that too for a profit?

Since compensation based on cost of production, as is apparent, does not offer full indemnity to the manufacturer, such a proposition which will prevent the insured from obtaining full indemnity must certainly be wrong as was categorically stated in the insurance case law. That is not all, it is the stated intention of the policy, in the preamble itself, that the company will pay to the insured, value of the property at the time of happening of its destruction or the amount of such damage or at its option reinstate or replace such property or part thereof. Read together, as it should be, the spirit behind the contract of insurance is abundantly clear - the insurers shall undertake to pay the value of the damaged property or reinstate, i.e. replace, it in a former position so as to restore the same, as the circumstances warrant, in a reasonably sufficient manner, as was elaborated in the governing condition of reinstatement in the policy. Viz. condition No 9 of the Standard Fie and Special perils Policy.

The argument that a given finished product is unique to the manufacturer and thus precludes the possibility of its reinstatement by the insurers under this condition is fallacious. Most of the manufactured goods are generic in nature which can be reinstated by procuring them from the market, at the market price. Even in case of brand items, the same are usually available for procurement, from the insured’s distributors, albeit at dealer’s price, to affect reinstatement. Even otherwise, in theory and practice, the insurers can place “an order” on the insured for effecting reinstatement; obviously the governing rate will be the manufacture’s sale price.

If one were to argue that reinstatement is only an option the insurers have reserved to exercise, it can be said against it that it is not so much the physical reinstatement that mattes by the spirit behind the intention to restore that counts. The proposition that he insures have the option to reinstate but the insured has no access to the reinstatement value, besides making the contract of insurance fall afoul as on sided, goes against the grains of natural justice under the common law.

Be that as it may, the invalidity of the mode of compensation based on cost of production will be amply clear, seen against the indemnity offered to the finished products in a premises other than that of the manufacturer’s like that of wholesalers - at the purchase price which is nothing but the sale price of the manufacturer! What would be the position, if the manufacturer were to create a marketing agency, a separate entity, and transfer his interest of goods to it, on paper, through ‘credit sale’ while physically retaining them in the warehouse, hitherto known as finished products godown, and obtains an insurance cover for them? The conventional wisdom would advocate indemnity on the sale price. The obvious question thus arises is when sale price is honoured ‘de tour,’ why should it be otherwise ‘ab initio’, and the logical answer that emerges is this: if there is a preponderant possibility of the finished goods moving out of the manufacturer’s premises, and into the market place, in the normal course, then the sale price and sale price alone should be the basis of indemnity ‘in situ’.

When, on the subject of indemnity, it is imperative to ensure that the insured should not be more than fully indemnified. Thus, in such cases of loss involving finished goods, where the manufacturer is unable to effectively market them, may be for a variety of reasons, then indemnifying loss of them on their sale price, in effect means selling the things for him, by default, which he himself was unable to do so, for an undue profit; in which case the reasonable proportion would be to base the indemnity on cost of production. However, with regard to obsolete, obsolescent, or aged stocks, a suitable mode of indemnity has to be evolved. Though rare, another loss situation, a product of the modern marketing strategy called test marketing, could beckon, where the redundant stocks of a flopped test-marketed product may come up for appraisal. Needless to say, the value of such stocks to the insured is not what is indicated on the price tag.

Thus, each loss may have its unique features but when striving to arrive at a reasonable compensation in each case, the aspects to bear in mind are the value of the damaged items to the owner, the interest he has in it and his right to be indemnified fully and only fully.

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