Choosing the right sum insured, and why book value is the wrong number

Sum insured is the number most often set by whatever the business felt it could afford, and it is one of the few insurance decisions where getting it wrong reduces every settlement rather than only the largest one.

Buildings

Insure at reinstatement cost: the cost of rebuilding the structure today, including demolition and debris removal, professional fees for architects and engineers, and any additional cost of complying with current building regulations that did not apply when it was originally constructed.

Exclude the land, which cannot burn. Market value is irrelevant in both directions - a building in an expensive location does not cost more to rebuild, and a building in a cheap one does not cost less.

Plant, machinery and equipment

On a reinstatement basis, insure at the cost of replacing with new equivalent equipment, including freight, duty, installation and commissioning. Book value is an accounting construct produced by a depreciation schedule and has no relationship to what replacement costs.

Imported machinery deserves particular attention, because the rupee cost of replacement moves with the exchange rate independently of anything happening in your business.

Stock: the peak, not the average

Stock values fluctuate, and losses do not politely occur in the quiet season. A business whose stock ranges from ₹40 lakh to ₹1.6 crore across the year and insures at ₹80 lakh is significantly underinsured for the months that matter most.

Insure the peak, or use a declaration policy. Insuring the average means being underinsured exactly when the stock is highest.

A floater or declaration-based policy is designed for this. You insure at peak, declare actual values periodically, and the premium is adjusted at the end of the period - so you pay for what you actually carried without being exposed at the top of the cycle.

Business interruption

The sum insured here is gross profit, defined in the specific way the policy defines it - usually turnover less specified variable costs, which is not the same as accounting gross profit. Get this from your accountant using the policy's definition rather than assuming.

The indemnity period is the other half of the decision, and it is more often wrong than the sum. It must cover the full time from the loss to the point where the business returns to its previous trading level - which includes lead times for machinery, statutory approvals, reconstruction and the slow rebuild of a customer base. Twelve months is the default and is frequently inadequate for anything involving imported plant or planning permission.

Keeping it current

Review annually against current costs. Construction and equipment costs in India have moved substantially in recent years, and a sum insured that was correct three renewals ago is very likely inadequate now.

For significant property, a professional valuation every few years is worth the fee. It costs a fraction of what an average-clause reduction on a single claim would.