It’s time to discuss replacement policies compared to indemnity policies.

Don’t assume your policy will replace everything new for old

People usually take out insurance on the simple premise that the insurer replaces what is damaged.

That is not, however, always how it works.

Recently, a Leonard & Welch client lodged a claim for a bathroom leak. Lloyd’s was the insurer.

The claim experience was ugly.

The Lloyd’s policy was an indemnity policy, not a replacement policy. That difference can make a very big difference in what you receive come claim payment time.

Under the indemnity policy, the bathroom damage was assessed at $10K because the insurer considered the building’s age and the age of the tiles, pipes, and other components. The actual replacement loss was closer to $25K.

The suggestion that insurers can still provide indemnity policies for partial losses is ridiculous. I thought I would explain the difference between the two policy types to help people avoid being caught out by the fine print.

Replacement Cover vs Indemnity Cover – They’re Not The Same Thing

In everyday terms, replacement cover is the better bargain. It covers the cost of repairing or replacing the property so that it is substantially the same as when new.

 Indemnity cover is different. It is based on the property’s condition at the time of the loss, taking into account factors such as age, wear and tear, and remaining useful life.

That means one starts with new value. The other starts with used value.

That is not a technical quibble. It is a difference that can leave you significantly out of pocket.

 Why this matters so much at claim time

This is where insurers catch people out. Most insureds (people like you and me) look at a loss and think: what will it cost me to replace this now?

The insurer, if it is working under an indemnity clause, may ask a very different question: what was this item worth in its used condition just before the loss?

Those are two very different questions, and they often produce two very different numbers.

An older building item, an ageing fit-out, or plant and equipment may cost a lot to replace today. But if the policy responds on an indemnity basis, the insurer may strip out a fair bit for age and condition, leaving you to fill the gap.

That is the sort of unpleasant surprise no one wants after a fire, storm, flood, or other major loss.

 Even replacement cover can fall back to indemnity

This is another trap. Many policyholders assume that if their policy starts on a reinstatement basis, it will stay there. And that is not necessarily the case.

The wording may require rebuilding, repairs or replacement to begin within 12 months or to be carried out diligently. If that does not happen, the insurer can fall back to indemnity value.

That matters in the real world because delays happen all the time. Builders are hard to get. Councils are slow. Funding becomes an issue. Scope disputes drag on. Before long, a claim you thought would be settled on a replacement basis can end up being assessed on an indemnity basis. That can be a very nasty turn.

What should people do before taking out cover?

The simple answer is this: do not just ask what the policy covers. Ask how the insurer will assess the loss. That is what really matters.

Before taking out a Lloyd’s policy, people should check:

• how the policy defines indemnity value
• how it defines reinstatement cost
• what the insurance certificate says
• whether delay changes cover type

Those are not side issues. They are what matters when things go wrong.

 The takeaway

Here is the short point.

 Do not assume your insurer will pay the full cost of replacing damaged property with new property unless the wording clearly says that it will.

If the policy works on an indemnity basis, the insurer may only owe the value of the property in its aged and used condition at the time of the loss.

That is why people thinking about taking out cover need to read the wording carefully before they sign up, not after the claim has gone sideways.

 Final word

Lloyd’s-backed policies can be useful products, especially for niche or hard-to-place risks. But approach their policies with caution.

When comparing policies, do not stop at the premium or the headline sum insured. Look at how the insurer pays out.

The difference between indemnity cover and replacement cover can mean the difference between being properly insured and being left seriously out of pocket.

Your insurance company should be standing by your side when you need it to. Indemnity cover makes that seem less likely.

Help

There is, of course, more to know than is covered here. As the usual legal disclaimer goes, the information here is of a general nature because legal advice always depends on your circumstances.

You can call us at (03) 9969 7077 or via email at info@leonardwelch.au.

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