Principles and Practices of Insurance – Study Material
UNIT – IV
FIRE INSURANCE
Fire Insurance – Common policies in Fire Insurance – Average Clause in Fire Insurance
Policy – Rights of the Insurer – Procedures for Fire Insurance Claim – Types of Losses
due to Fire – Procedures for calculating claim for loss of stock.
MEANING AND DEFINITION OF FIRE INSURANCE:
Meaning: Fire insurance is an agreement between insurer and the insured, under which the
insurer agrees to indemnify the loss caused by fire, to the insured, in consideration of certain
payment, called premium.
Definition: V.R. Bhushan and Prof. R.S. Sharma: A fire insurance may be defined as an
agreement whereby one party, in return for a consideration, undertakes to indemnify the other
party against financial loss which he may sustain, by reason of certain defined subject-matter
being damaged or destroyed by fire or other defined perils up to an agreed amount.
T.R. Smith: Fire insurance may be defined as a contract where by the insurers, in return for a
consideration, known as premium, undertake to indemnify the insured against financial loss
which he may sustain, by reason of certain defined property, known as the property insured,
being damaged or destroyed by fire or other perils within a stated period of the liability of
insurer, being limited to a specified amount, called the sum insured.
Fire insurance has also been defined under Section 2 of the Indian Insurance Act, 1938, as
follows:
“Fire insurance business means the business of affecting, otherwise than incidentally the some
other class of insurance business, contracts of insurance against loss by or incidental to fire or
other the occurrence customarily included among the risks insured against in fire insurance
policies”.
Fire: The term ‘fire’ in a contract of fire insurance is used in its popular and literal sense. It
means the production of light and heat by combustion. Combustion occurs only at the actual
ignition point. Hence, there is no fire without ignition. Loss or damage which occurs as a result
of putting out the fire would also be covered by the fire risks. Fire policies are not covered
through fire caused by earthquakes, riots, civil commotion, foreign enemy, rebellion etc.
SUBJECT MATTER OF FIRE INSURANCE
Subject matter of fire insurance may be of any kind of moveable and immoveable property
having pecuniary value. The property intended to be insured must be properly described. As per
fire insurance, it is governed by Tariff; the following are the example of insurable property such
as:
1) Building
2) Electrical installation in buildings
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3) Contents of building such as machinery, plant and equipment, accessories etc.
Prepared by Dr. L. Eswaran, Assistant Professor of Commerce, Thiagarajar College, Madurai - 9
Principles and Practices of Insurance – Study Material
4) Goods (raw materials, work in progress, semi finished goods, finished goods, packaging
materials) in factories and godowns
5) Goods in open
6) Contents in dwellings, shops, hotels, etc.
7) Furniture, fixture and fittings
8) Pipelines (including contents) located inside or outside compound etc.
FUNDAMENTAL PRINCIPLES OF FIRE INSURANCE
The following are the fundamental principles essentials for a valid contract of fire insurance.
A contract of indemnity – Insurable interest to exist both at the time of effecting the insurance as
well as the time of loss – Utmost good faith or Uberrimae fidei – Causa Proxima) – A contract
from year to year – Subject to the principles of subrogation and contribution.
COMMON TYPES OF FIRE POLICIES
There are various types of fire insurance policies which are issued to meet the varying needs of
the individual persons.
1. Specific Policy: A specific policy is one where the insurer undertakes to make good the loss
upto the amount specified in the policy, irrespective of the value of the property.
For example, if a property worth ₹.2,00,000 is insured for ₹.1,00,000 but the actual loss is only
₹.1,50,000 he can only recover the actual loss if it is equal to or less than the value of the policy,
but if his loss is more than the sum insured, he can recover only the amount of policy.
2. Valued Policy: A valued policy is usually taken where it is not easy to determine the value of
the property. For example, works of art, pictures, sculptures etc., whose value cannot be
determined easily. In the case of total loss in the valued policy, the insurer undertakes to pay the
value of the property as mentioned in the policy, or the declared value, irrespective of its actual
or market value. Such policies are, however, not very common in fire insurance.
3. Average Policy: A fire policy containing an average clause is called an average policy. Under
this policy, the insured is penalised for under-insurance of the property. In other words, the
insured is considered to be a self insurer to the extent of under insurance.
4. Floating Policy: A floating policy covers loss on goods which are lying in different places.
For example, a dealer may take out only one floating policy, instead of separate specific policies
for all his goods, some of which may be in warehouses, others in railway stations, shop counters
etc. This policy is useful when the insured is in a position to declare only the total value at risk
and not separate values in separate risks.
5. Replacement Policy: Replacement policy is otherwise termed as Reinstatement policy. This
policy is issued in respect of building, plant and machinery, furniture and fixtures and fittings
etc. Under this policy, the insurer undertakes to pay the cost of replacing the property instead of
paying compensation to the insured for the property destroyed. In short, the damaged property is
replacement by a new property.
6. Declaration Policy: Declaration policy may be granted only in respect of stock of inventories
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(stock of raw material, stock of work in progress and stock of finished goods) of the insured.
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Generally, levels of stock which are subject to frequent fluctuations in value or in volume,
Prepared by Dr. L. Eswaran, Assistant Professor of Commerce, Thiagarajar College, Madurai - 9
Principles and Practices of Insurance – Study Material
present a special problem for insurance. In such a case, the businessman takes a policy for a
maximum expected amount and the premium is paid. Every month the insured must declare in
writing the stock covered under the policy to the insurance company. At the end, the premium is
adjusted accordingly.
7. Comprehensive Policy: This policy undertakes full protection not only against the risk of the
fire but combining with the risk against burglary, riot, civil commotion, theft, damage from pest,
lightning. The policy is also termed as All Insurance Policy. Here, the comprehensive does not
mean that every type of risk is covered. Such policies are not common in our country.
8. Consequential Loss Policy: Under this policy, the insurer agrees to indemnify the insured for
the loss of profits which he suffers due to dislocation of his business as a result of fire. This type
of policy is also called as “Loss of profit Policy”. Thus, this policy covers:
i) Loss of goods or property damaged
ii) Loss of net profits
iii) Outstanding expenses (interest on debenture, salaries, rent on building etc.)
iv) Prepaid expenses etc.
9. Adjustable Policy: This policy is nothing but an ordinary policy on the stock of the
businessman with liberty to the insured to vary at his option. The premium is adjustable pro-rata
according to the variation of the stock. The adjustable policy is granted to remove the
disadvantage of declaration on policy. This is issued for a definite term on the existing stock.
The premium is calculated in the ordinary manner and is paid in full at the inception of the
policy. Whenever, there is variation in the stock, the insured informs the insurer. As soon as the
information of variation is received, the policy is suitably endorsed and the premium is adjusted
on a pro-rate basis. The policy amount will, thus, be changeable from time to time.
10. Building in the Course of Construction: Like floating policy, two types of policies are
available for buildings in course of construction and machinery in course of installation. The
floating policy is issued for a sum insured initially and it goes on increasing as the construction
of building work progresses. The premium increases on sum insured on pro-rate basis. The
policy is issued for the total value of construction. The calculation of premium is based on half
the tariff rates.
11. Blanket Policy: This type of policy covers both fixed and current assets of insured
manufacturer. No distinction between furniture, machinery, building and stock is made.
12. Excess Policy: When there is a fluctuation in the stock from time to time in that case it is not
possible to take one specific policy. In this case insured takes two policies – one “First Loss
Policy” and second “Excess Policy”. The “First Loss Policy” will cover that value of stock
below which the value never goes. “Excess Policy” will cover the maximum additional amount
by which the stock rises at different periods.
13. Maximum Value of Discount Policy: Under this policy, no declaration or adjustment of
policy is required, but the policy is taken for maximum amount, and full premium is paid
thereon. At the end of the year, in the case of no loss, one-third of the premium paid is returned
to the policy holder. This policy is similar to the declaration policy where botheration of
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checking and recording declaration is avoided. It serves a s rough and ready method of coverage
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Prepared by Dr. L. Eswaran, Assistant Professor of Commerce, Thiagarajar College, Madurai - 9
Principles and Practices of Insurance – Study Material
for the maximum amount. This policy is not issued on all types of commodities and is confined
only to selected commodities.
14. Sprinkler Leakage Policies: This policy insures the destruction of or damage to by water
accidentally discharged or leaking from automatic sprinkler installation in the insured premises.
However, the discharge or leakage of water due to heat caused by fire, repair or alteration of
building, sprinkler installation, earthquake, war explosion are not covered by this policy.
AVERAGE CLAUSE IN FIRE INSURANCE POLICY
The clause is usually inserted in all general insurance contracts to discourage under insurance.
The clause limits the liability of the insurer to that proportion of the actual amount of loss which
the insured amount bears to the actual value of the property.
RIGHTS OF THE INSURER
The following are the rights of the insurer:
1. Rights to avoid the policy: An insurer has a right to void the policy where the subject matter
is not specified honestly or wilful fire is caused by the insured or with his connivance.
2. Rights of entry control over the property: Where any loss or damage of property insured
arising of an outbreak of fire, the insurance company has rights to enter the premises and take
possession of the building or property. It is essential for the insurer to ascertain the cause of loss
or damage to minimise the loss and to protect the salvage.
3. Right of reinstatement: An insurer has a right of reinstatement or replacement of damaged
property under which insured instead of paying the amount of loss or damage in money. Here,
the insured has no right to claim reinstatement.
4. Right to subrogation: Subrogation is the principle by which the insurer on paying the loss to
the insured becomes entitled to all the rights and remedies available to the insured in respect of
the subject matter insured against. This principle holds goods in fire insurance. For example,
when loss is caused by the wrongful act of a third party, the insurer can proceed against the third
party after paying the insured his loss.
5. Right to Contribution: This doctrine of contribution also applies to fire insurance contracts
of indemnity. According to this principle, in case a person has taken out more than one policy
against the same risks, the insurers are to share the loss in proportion to the amount assured by
each. If an insurer pays more, he can recover the excess from his co-insurers to contribute
proportionately towards the loss.
6. Right to Salvage: In the case of any loss due to fire, it is the duty of the assured to hand over
to the salvage to the insurance company. The insurer has right to ascertain the claim to be made
should be for the exact value of the goods damaged or destroyed at the date of fire.
PROCEDURE FOR FIRE INSURANCE CLAIMS
The following procedure is followed while claiming the compensation of fire loss:
1. Receipt of claim intimation: On receipt of claim intimation the following main step is to be
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checked by the Insurance Company whether:
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a) The policy is in the force.
Prepared by Dr. L. Eswaran, Assistant Professor of Commerce, Thiagarajar College, Madurai - 9
Principles and Practices of Insurance – Study Material
b) The items of goods affected are the same as covered under the policy.
c) The location involved is the same as covered in the insurance policy.
2. Entering it in the claim register: After verifying the policy, the claim is registered and a
claim number is allotted to the insured. This claim number is used for future reference. The
claim register contains the details of the claim number, date of fire, name of the insured person,
the sum insured, policy number, the situation of risk where the loss took place, estimate value of
the loss, and name of the surveyors. This type of columns is required in the claim register.
3. Claim Form: After register of claim in the claim register, a claim form is sent to the insured
person for completing and returning it to the Insurance Company. In this claim form, the
following contents are to be mentioned:
a) Name of the Insured
b) Policy Number
c) Address of Insured
d) Details regarding damaged property
e) Date and time of the fire
f) Cause and circumstances of the fire
g) Value of the property at the time of fire
h) Amount claimed after deduction of salvage value
i) Situation of the premises in which fire occurred
j) Capacity in which the insured wants claim means whether as owner, mortgagee etc.
k) Is any other insurance policy is in force upon such property?
f) Occupancy of the premises in which the fire occurred
4) Survey: If the claim is simple and amount of loss is small; in that case, it is settled on the
basis of the claim form and if the amount of loss is large, then independent loss surveyors are
nominated to investigate and report on the cause of loss, extent of loss and compliance with the
terms and conditions of the policy.
5) Discharge Voucher: After the above formalities, a discharge voucher is sent to the insured
for his signature and return. On receipt of it, a cheque in settlement is sent.
6) Recording: Before the cheque is released, the payment is recorded in the claim register. The
payment is also recorded in the relative policy file and the sum insured is reduced by the amount
of the claim. The intimation is sent to the insured that the sum insured can be reinstated on
payment of proportionate premium from the date of reinstatement of the sum insured to the date
to expiry of the policy.
TYPES OF LOSSES DUE TO FIRE
Loss due to fire is of two types such as:
I. Loss of Assets or Stock
II. Loss of Profit
1. Loss of Assets or Stock: The insured, in the event of fire accident, informs the insurer
(Insurance Company) of the loss of property and stocks. The insurance contract is
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usually for a year and the insurer indemnifies the insured for the loss suffered. In
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response to the request of the insured, a technical expert is entrusted by the Insurance
Prepared by Dr. L. Eswaran, Assistant Professor of Commerce, Thiagarajar College, Madurai - 9
Principles and Practices of Insurance – Study Material
Company; and the technical expert, after investigation, sends his report by stating the
amount payable by the Insurance Company to the insured. His report, after a careful
investigation, must reveal the causes due to which the fire broke out and whether the
claim is covered by the policy or not.
2. Loss of Profit: In the event of fire, it not only destroys the properties but also affects the
earning capacity of the business. This results in partial or total stoppage of business
leading to the reduction in the profit which is called “loss on profit”. An ordinary fire
insurance policy covers the loss on account of stock or properties destroyed by fire, but it
does not cover such loss of profit. In order to give complete protection to the insured, a
new type of insurance called as “Consequential Loss Insurance” or “Loss of Profit
Insurance”.
Under Consequential Policy, the insurer indemnifies the policy holder against losses
arising from the suspension, wholly or partly of the activities of the business caused by
fire. Loss of profits insurance covers the following risks consequent upon fire:
a) Loss of Profit due to inability to produce
b) Loss of Profit due to short sales
c) Loss due to non-recovery of standing charges such as salaries, rent and rates, taxes
etc.
d) Increased working expenses incurred by the insured during the indemnity period in
order to maintain normal business activity.
PROCEDURES FOR CALCULATING CLAIM FOR LOSS OF STOCK
The values of assets other than stock can be ascertained at any time. The stocks with which
he deals are not maintained daily. Moreover, stock-taking every day is not possible and is a
very difficult job. In such a situation, one has to estimate the loss of value of stock on
account of fire by preparing a statement or a Memorandum Trading Account.
The following are the various points to be considered for calculating claim for loss of stock:
1) In order to lodge the claim, it is essential to calculate a) Total stock in the firm on the date
of fire, and b) Stock salvaged.
2) Ascertain the actual loss of stock due to fire; the claim for loss of stock depends upon
actual loss of stock due to fire.
3) The actual loss of stock is equal to “Total stock on the date of fire less stock salvaged”.
4) Total stock is equal to stock in the beginning plus purchases (from the beginning of
accounting year to the date of fire) less cost of stock sold (from the beginning of
accounting year to the date of fire).
5) Cost of goods sold is calculated by deducting gross profit from sales.
6) The next step is to prepare Memorandum Trading Account of the current year upto the
date of fire on the basis of opening stock purchases and sales from the beginning of the
year upto the date of fire and estimated gross profit on the basis of last year’s gross profit
ratio. The balancing figure on the credit side of the Memorandum Trading Account
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reveals the value of stock on hand on the date of fire.
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Prepared by Dr. L. Eswaran, Assistant Professor of Commerce, Thiagarajar College, Madurai - 9
Principles and Practices of Insurance – Study Material
7) When ledger account for stock is not maintained, Gross Profit can be calculated with the
help of sales and rate of gross profit. The following relevant points are to be considered.
a) Gross Profit Ratio = Gross Profit X 100 / Sales
b) Previous Accounting year’s gross profit and sales can be used for gross profit ratio.
c) Rate of profit is given sometimes ‘on sales’ and sometimes ‘on cost’.
d) In case, it is given ‘on cost’ then it must be converted to ‘on sale’.
e) In case, it is not given then it must be calculated by preparing the trading account of
the preceding year or years.
However, it must be remembered that the effect of abnormal happenings Example:
a) Variation in the practice of stock valuation.
b) Selling a part of goods either at a loss or at a rate of, profit which is different form
that normally followed.
c) Charging productive or direct expenses as indirect expenses must be nullified at the
time of preparing the trading account for the calculation of rate of gross profit.
This is necessary because the rate of gross profit has a direct impact on the calculation of claim
for loss of stock. Higher the rate of gross profit more is the stock at the end (because it is a
balancing figure) and more is the claim. Therefore, insurance company is very particular about
the rate of gross profit used for the calculation of claim. The insurer has to ensure that it is not
higher that what it should be.
Average Clause: A fire insurance policy usually includes an average clause to discourage under
insurance of stock or of any asset. The effect of this clause is that if the value of stock or any
asset insured on the date of tire, is more than the amount of policy taken, the full value of stock
or any asset destroyed does not become payable to the insured but the insurance company pays
the proportion of the loss which the amount of policy taken bears to the total value of stock or
any asset in hand on the date of fire. It can be explained as below:
Actual value of stock destroyed = Stock on the date of fire – Salvaged Value
Claim to be lodged = Value of insurance policy X Value of stock destroyed / Value of stock in
hand on the date of fire.
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