The company insured its machinery at new value and has paid the premium on the basis of the new purchase price for years; then comes a fire or a burst pipe, and for the fifteen-year-old press the insurer transfers a fraction of the new price, “at depreciated value”. The managing director rightly asks: then what was the new value good for? As a broker, I see this as the biggest surprise in claim payments at companies working with older machinery, even though the rule is there in the policy conditions – it is just that few people read it when taking out the policy: new-value cover is not unlimited, and above a certain degree of depreciation the insurer pays the actual value. In this article I go through where this threshold comes from, how depreciation is calculated, what the second – often forgotten – condition is, and what the company can do when taking out the policy and when a loss occurs.
- According to guidance from MABISZ (the Hungarian insurers' association), for fixed assets with technical depreciation of 30–50% or more relative to new value, the insurer pays the actual (depreciated) value – the threshold varies by insurer; one Hungarian set of general conditions, for example, sets it at 30%.
- Under typical policy conditions, the difference between new value and actual value is paid only if the property is actually repaired or replaced in new condition – if you do not replace it, you receive the depreciated value.
- The premium is based on new value, but above the threshold the indemnity is the depreciated value: with older machinery it is therefore worth clarifying the threshold, the reinstatement condition and the valuation basis before taking out the policy, and reviewing the depreciation calculation item by item when a loss occurs.
What does new value promise, and where is its limit?
New-value insurance is based on setting the sum insured not at the current, used value of the property but at its new purchase or production cost, and in a loss the insurer pays this amount. One Hungarian set of general property insurance conditions defines new value as “the purchase or production cost (for buildings or structures, the rebuilding cost), at the time of the loss, of a new item of property that is identical or equivalent in its technical characteristics, capacity and economic indicators”. The over-insurance rule of the Hungarian Civil Code (Ptk.) expressly permits this: as a general rule the sum insured may not exceed the value of the property, but a contract may also be concluded for the value of repairing the property or acquiring it in new condition. The policy conditions, however, set a limit. According to the information notice of the Industrial and Technical Insurance Committee of MABISZ (the Hungarian insurers' association), for fixed assets “with technical depreciation of 30–50% (this figure may vary by insurer!) or more relative to new value”, the insurer pays the actual (depreciated) value. The general conditions mentioned above, for example, put it this way: if the technical depreciation of the damaged property exceeds 30% at the time of the loss event, the insurer's benefit may not exceed the amount calculated under the rules for property insured at technically depreciated value. Another insurer draws the line at 50% or elsewhere, and some apply different thresholds to buildings and machinery – this varies from one set of conditions to another, so you need to look it up in the conditions of your own policy. The basics of the two valuation methods are presented in the new value versus actual value article; here the subject is the rule for tipping over from one to the other.
How is depreciation calculated?
Under the policy conditions, technically depreciated value is “new value reduced by the degree of technical depreciation”. The key word is technical: the degree of depreciation is not determined by the depreciation in the accounts. A machine may be written down to zero in the books while being in good technical condition, and vice versa – according to the MABISZ notice, however, for fully written-off fixed assets and those permanently taken out of use the insurer pays the actual (depreciated) value, so for machines written down to zero but still operating, the relevant clause of your own conditions has to be checked separately. In a loss, the degree of depreciation is estimated by the insurer's loss adjuster on the basis of the property's age, intensity of use, maintenance, condition and the market situation of similar machines – the method varies by insurer and by adjuster, and there is no uniform table. Three things work in the company's favour: documented maintenance and refurbishment, invoices for major overhauls carried out, and the machine having actually been operating and producing before the loss. Without these, the adjuster typically estimates on the basis of age, which is unfavourable for the company in the case of a well-maintained old machine. The threshold is assessed item by item: the average condition of the asset group as a whole does not help the one machine that falls above the limit. That is why it pays to keep the machinery and equipment inventory in such a way that it includes the year of purchase, the new value, major refurbishments and a reference to the maintenance log – in a loss, this is one of the most useful counters in a dispute over depreciation.
The second condition: only if you actually replace it
Alongside the depreciation threshold there is another, often forgotten rule. Hungarian policy conditions typically state that the insurer pays the difference between new value and actual value only if the repair or the replacement in new condition actually takes place; one Hungarian set of commercial property insurance conditions puts it word for word like this: “the insurer pays the difference between the actual value of the property and the new value only if the repair, replacement in new condition or purchase of the fixed asset actually takes place”. In practice, this means a two-stage payment: the insurer first transfers the actual value, and then the difference after proof of replacement – typically an invoice. Some conditions also set a deadline for the replacement, and some require an asset with the same purpose, put into operation at the site. So if, after the loss, you decide not to buy the machine again but to reorganise the activity or spend the money on something else, you receive only the actual value, even with “intact” new-value cover below the threshold. When reading the loss assessment and the settlement offer, it is worth paying particular attention to these two stages – the article on loss assessment and settlement goes through the other elements of the calculation as well.
Premium at new value, indemnity at depreciated value: the underinsurance trap
The painful point is this: the sum insured has to be stated at new value, and the premium is calculated from it too, but above the threshold the indemnity is the depreciated value. The policy conditions also assess underinsurance according to the valuation basis: if the sum insured of the property is lower than its actual value under the given valuation basis, the insurer pays the loss proportionally – one Hungarian set of conditions softens this by not applying proportional indemnity up to 15%, while other conditions have no such tolerance or a different one. If you insure old machines for a lower amount on the grounds that “they won't pay new value anyway” because of the threshold, you become underinsured and receive proportionally reduced payments even for partial losses – this is discussed in detail in the article on underinsurance. There is, however, a choice: under the policy conditions, by separate agreement the property can also be insured on a basis other than new value – for example, at technically depreciated value or at book value. For old but working machinery, this may on the whole be more reasonable than paying the new-value premium for cover that, because of the threshold, will not pay new value in a loss anyway. Machinery breakdown insurance follows a separate rule: according to the MABISZ notice, it pays the depreciated (actual) value of the insured property at the time of the loss, so there the question of new value arises differently from the outset.
What should the company do when taking out the policy and in a loss?
When taking out the policy, three questions are worth asking: what is the depreciation threshold in the conditions, and does it differ by asset group; what reinstatement condition and deadline apply to payment of the difference; and will the insurer provide new-value cover without a threshold for old but operating machines, or is it better to insure them at actual value. Record the year of purchase, the new value and major refurbishments in the machinery inventory, because in a loss this is the basis of the depreciation estimate. In a loss, ask for the loss adjuster's calculation item by item: what depreciation percentage was applied to which machine, and whether the indemnity is based on new value or depreciated value; hand over the maintenance log and the invoices for refurbishments; and prove the replacement with an invoice within the deadline set in the conditions. If you let me know, I also present these points when comparing the offers; the primary route for reporting a claim is the insurer's claims line, and if the case gets stuck or becomes disputed over the depreciation calculation, I help where I can on the company's behalf. I cannot promise anything: the insurer pays only for what is an insured event under your contract, and only in the way its conditions describe the valuation.
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Sources
- MABISZ (Hungarian insurers' association) Industrial and Technical Insurance Committee: Information notice on property, engineering and business interruption insurance (closed 20 December 2019) – Chapter I: actual value paid above 30–50% technical depreciation; Chapter III: machinery breakdown at depreciated value
- Allianz Hungária: General insurance conditions – Property insurance (AHE-43140/2P), 6.4.1 new value, 12.5.1 technical depreciation exceeding 30%, 12.5.5.1 proportional indemnity
- Aegon (now Alfa) TREND Property Insurance – commercial property and liability insurance conditions, clauses IV.3–6 (new value, underinsurance above 15%), clause VII.5 (difference only if actually replaced)
- Hungarian Civil Code (Ptk.) – Act V of 2013, indemnity insurance rules (over-insurance; insurance up to the value of repair or acquisition in new condition)
