illustrations on Computation of Claim for Loss of Stock (including Over Valuation and Under Valuation of Stock, Abnormal Items and application of Average Clause)

When computing a claim for loss of stock under a fire insurance policy, various factors such as overvaluation, undervaluation, abnormal items, and the application of the average clause come into play. These considerations affect the final claim amount the insured can receive. Below are illustrations to explain each scenario.

illustration 1: Normal Case (Without Overvaluation, Undervaluation, or Abnormal Items)

• Stock at the beginning of the year: ₹3,00,000
• Purchases during the year: ₹7,00,000
• Sales during the year: ₹8,00,000
• Gross Profit Margin: 25% on cost
• Stock salvaged after the fire: ₹50,000
• Stock destroyed by fire: Calculated below
• Sum Insured: ₹7,00,000
• Actual value of stock at the time of fire: ₹5,00,000

Step-by-Step Calculation:

1. Gross Profit:

Gross Profit = 25% on Cost of sales

Cost of sales = Sales − Gross Profit = ₹8,00,000 − 25% = ₹6,40,000

2. Closing Stock:

Closing stock is computed based on stock at the beginning, purchases, and cost of sales.

Closing Stock=₹3,00,000+₹7,00,000−₹6,40,000=₹3,60,000

3. Loss of Stock:

The amount of stock destroyed by fire is the difference between the closing stock and the salvage value.

Stock Lost = ₹3,60,000 − ₹50,000 = ₹3,10,000

4. Claim Amount (No Average Clause Applied):

Since the stock lost is less than the sum insured (₹7,00,000), the insured can claim the full ₹3,10,000.

illustration 2: Overvaluation of Stock

Overvaluation of stock means that the value of stock recorded is higher than its actual value. This leads to discrepancies in the computation of claims, as the insurer compensates based on the real value of the stock at the time of loss, not the inflated valuation.

• Stock at the time of fire (Recorded Value): ₹6,00,000
• Actual Stock Value: ₹5,00,000
• Sum Insured: ₹5,50,000
• Salvaged Stock: ₹1,00,000
• Stock Destroyed (Recorded): ₹6,00,000 – ₹1,00,000 = ₹5,00,000

Since the recorded stock value is overstated, the claim will be calculated on the actual value of the stock:

1. Actual Stock Destroyed:

Stock Lost = Actual Stock Value − Salvaged Stock = ₹5,00,000 − ₹1,00,000 = ₹4,00,000

2. Claim Amount (No Average Clause):

The sum insured covers the loss. Therefore, the claim amount is ₹4,00,000.

illustration 3: Undervaluation of Stock

Undervaluation of stock occurs when the stock is recorded at a value lower than its actual worth. In this case, the insurer will pay based on the actual value of the stock, leading to higher compensation than expected by the insured.

• Stock at the time of fire (Recorded Value): ₹4,00,000
• Actual Stock Value: ₹6,00,000
• Sum Insured: ₹5,50,000
• Salvaged Stock: ₹50,000
• Stock Destroyed: ₹6,00,000 – ₹50,000 = ₹5,50,000

Step-by-step Calculation:

1. Stock Lost:

Stock Lost = ₹6,00,000 − ₹50,000 = ₹5,50,000

2. Claim Amount:

Since the stock lost (₹5,50,000) is equal to the sum insured, the entire amount will be paid by the insurer, i.e., ₹5,50,000.

illustration 4: Abnormal Items in Stock

Abnormal items refer to items that are not part of the normal stock, such as obsolete goods or items damaged before the fire. These items are excluded from the computation of the claim.

• Stock before fire: ₹4,50,000
• Abnormal Items (Damaged goods): ₹50,000
• Stock Salvaged: ₹1,00,000
• Sum Insured: ₹5,00,000

Step-by-step Calculation:

1. Normal Stock Value (Excluding abnormal items):

Normal Stock Value = ₹4,50,000 − ₹50,000 = ₹4,00,000

2. Loss of Stock:

Stock Lost = ₹4,00,000 − ₹1,00,000 = ₹3,00,000

3. Claim Amount (No Average Clause):

The claim would be ₹3,00,000, excluding the value of abnormal items.

illustration 5: Application of Average Clause

Average clause comes into effect when the sum insured is less than the actual value of the stock. The insurer then compensates the insured in the same proportion as the amount insured to the actual stock value.

• Actual Stock Value: ₹10,00,000
• Sum Insured: ₹7,00,000
• Stock Salvaged: ₹50,000
• Stock Destroyed: ₹9,50,000

Step-by-step Calculation:

1. Loss of Stock:

Stock Lost=₹9,50,000

2. Application of Average Clause:

The sum insured (₹7,00,000) is less than the actual stock value (₹10,00,000), so the insurer will apply the average clause to determine the claim amount.

Formula for Average Clause:

Claim Amount = (Sum Insured / Actual Stock Value) × Loss of Stock

Claim Amount = (₹7,00,000 / ₹10,00,000) × ₹9,50,000 = ₹6,65,000

Thus, under the average clause, the insured will receive ₹6,65,000 instead of ₹9,50,000.