QUESTION:
We have a claim where a settlement offer is to be based on indemnity value.
The item damaged is an artificial bowling green and the costs to reinstate include a number of different elements that make up the quote, being materials, labour, equipment hire, project management costs etc.
The wording notes the definition of indemnity value as :
Indemnity Value:
the value of insured property at the time of loss or damage, sufficient to place the insured back in the same financial position to that immediately prior to the loss or damage.
The insurer's offer of settlement is based on the full costs to reinstate divided by the lifespan (20yrs) x the remaining life (9yrs) So the depreciation is 55% across the board on all elements.
Our question is about the depreciation calculation.
On materials that wear we expect depreciation however should the elements of labour and machinery hire etc. also be subject to depreciation?
Could you provide some insight into what is able to be depreciated by the insurer?
STEVE KEALL ANSWERS:
Interesting issue.
In this case the insurer proposes an "across the board" rate of depreciation. This is a global assessment of the full cost of reinstatement which does not differentiate between plant & materials that would usually be subject to a straight-line depreciation (i.e., a fixed percentage for each year of age) and labour & incidental costs, which by their nature do not depreciate.
Insurer proposes conventional straight line depreciation which takes a starting (all inclusive) value (call that value A) and divides that number by the years of life of the assets in question (value B), and then multiplies that by the number of years left for those assets (value C).
The difficulty with this approach is that the insurer is not comparing apples with apples. A traditionally non-depreciable element like labour does not have years of life. So, computationally, this does not work.
The policy caters for depreciation-it is inherent in the concept of indemnity. So, it must be taken into account. Depreciation is not given a defined meaning. In these circumstances, I think the correct approach is to fall back on conventional valuation methods. "Straight line" depreciation is as described above, for which you would leave out labour and machine hire.
It may well be the case that the insurer has catered for the "non-depreciable" elements by enlarging the lifespan.
Intuitively, a lifespan of 20 years sounds like it is on the long side for an artificial surface: which is good for your customer. The shorter the life, the higher the depreciation rate amount, given that 11 years have passed. For example, if the lifespan was say 15 years then the depreciation rate would be 73. And if the lifespan were say 11 years then the residual value would be nil.
In terms of practical steps, you might want to contact the insurer to confirm its methodology. If it has catered for non-depreciable elements by using a generous, 20 year, time-frame, then in economic terms it would probably not make sense to make any challenge. If you did, it follows that it would use a shorter asset timeframe for the strictly depreciable elements to yield the same outcome.
