Value adjustment clauses in industrial property insurance: What you need to know

25th February 2023 by K. Ulmer

Value adjustment clauses in property insurance for industry & commerce are a really fine thing, because they

  • offer good protection against underinsurance
  • are a kind of precaution or buffer with regard to future price developments
  • automatically adjust the sum insured to inflation without any special agreement, even during the year
  • allow simple and inexpensive maintenance of the sum insured

To be fully effective, they must be properly understood. Above all, however, the corresponding value adjustments must be calculated and applied correctly.

This is what we will be dealing with today.

What is a Value adjustment clause?

Surcharge clauses are agreed both in buildings insurance and in business contents insurance – i.e. in the insurance of technical and commercial equipment.

The basic idea is to adjust the sum insured annually to current price developments by adding a value adjustment, so that the current insured values do not have to be determined anew every year. (Even though we would not object to this in principle, it would be total nonsense from an economic point of view!)

The purpose of the value adjustment clause is therefore to ensure that full compensation for damage is guaranteed despite increased insured values due to price increases.

In short: to avoid underinsurance.

Attention! However, the clauses only protect if both the sum insured and the value supplement were correctly assessed at the beginning of the insurance year!

Excursus: The correct sum insured

Whether the sum insured was correct is usually only determined when a loss occurs. The following applies: The responsibility for the sum insured lies with the policyholder!

You can read all about the correct sum insured here. You can find a checklist to help you see whether you need to take action here.

Value adjustment clauses come in two different forms:

  • Value adjustment without inclusion of portfolio increases
  • Value adjustment with inclusion of inventory increases

If increases in inventory are included, a third condition is added: the new acquisitions (increases in inventory) must be reported to the insurer in good time. Makes sense.

Important to know: Many insurers have agreed in their insurance conditions that the liability even includes double the value supplement if the sum insured and the value supplements have been determined by an expert![1] So double security without premium surcharge!

[1] See, for example, “Clauses for fire insurance” of the German Insurance Association GDV or HDI “Building block value surcharge”.

How are the value adjustments calculated?

From the basic sum to the sum insured

First, the current insurance values are converted to a uniform base year. Indices from the Federal Statistical Office are used for this purpose.

The current insured values can be either

  • the acquisition costs of a plant in the year of its acquisition or
  • the new values of the machinery determined on a certain date (e.g. by an insurance valuation).

Caution! However, the acquisition costs can often not be taken over as the insured value without further ado, for example if high price discounts have been achieved. This happens, for example, when you buy machines at trade fairs or at auctions.

In an expert opinion, the new values are usually determined independently of the historical acquisition costs.

The uniform base year to which the insured values are referred is specified by the insurer. Typically 1970 or 1980 are used, but other base years are also encountered. For buildings, the year 1914 is common.

The result is the so-called basic sum. This expresses what the machinery, equipment and factory buildings would have cost in the base year. Different acquisition dates are thus standardised to a uniform year.

Excursus Base years:

There are various reasons for the choice of base years. For the base year 1914 for buildings, for example, three criteria were given: stable construction prices, a gold-backed currency and the absence of extraordinary increases in construction prices. For the year 1970 for technical operating equipment, there were relatively stable prices for machinery – apart from inflation.

We will give an example:

You buy a machine for EUR 10 million this year. According to the index figures of the Federal Statistical Office, this machine would have cost EUR 2,061,856 in 1970 (base year). That is the basic sum.

The difference between 1970 and today is therefore EUR 7,938,144 or 385% in relation to the basic sum. That is the value added.

Depending on the price development, the price index changes in the following year and thus the value supplement, let’s assume to 390 %. Then the sum insured in the following year is

2,061,856 EUR (basic sum) x 390 % = 8,041,238.40 EUR (value supplement)

2,061,856 EUR (basic sum)
+ 8,041,238.40 (value supplement)
= 10,103,094.40 EUR (sum insured)

This sum (10.1 million EUR) would therefore have to be spent in the year after acquisition to buy a comparable machine.

As you can see, the value premium depends directly on the price index used and now we come to the crux of the matter:

Which index do I use?

There is an easy way and a right way:

The easy way – using a mixed index

If you want it simple, take

  • for the factory buildings: indices for commercial factory buildings (which we will not go into here due to lack of expertise)
  • for plant equipment, the index “Industrial machinery”.

The index “Industrial machinery” is a mixed index that is composed of the price developments for various types of machinery and operating equipment. It therefore reflects an average performance.

Attention: Since the end of 2022, the Long Series with which we are familiar and which contained the indices will be replaced. The well-known Fachserie 17 Reihe 2 lfd. Nr. 413, which contained the above-mentioned mixed index for commercial machinery, has now been replaced by this Statistical Report, for example. Yes, we too are still in the orientation phase …

But the ease of use is also the biggest drawback, because:

The price development for your machinery may well deviate considerably from the average price development!

If a mixed index is used, this can lead to considerable underinsurance (risk!) or overinsurance (premium alarm!) over time.

In many cases it is therefore advisable to determine an individual price index, on the basis of which individual value supplements are then calculated.

The right way – determining an individual index

In order to realistically reflect the performance of one’s own machinery, equipment, machine parts or production sites are weighted – depending on the specific circumstances in a company.

Take a look at the following examples, which illustrate the problem well.

(The examples show the price development since 2015 because I was a bit too lazy to convert them to 1970 or 1980. But the effect – how prices drift apart – can still be seen very clearly).

Price development of lathes

Price development of lathes

While the conventional lathe has had a performance since 2015 of 120% – relatively close to the mixed index (118%), the horizontal lathe is well above (130%) and – at the other end of the spectrum – cylindrical grinding machines are well below at 111%.

Another example

  • Commercial dishwashing machines (143 %), such as a Bartscher push-through dishwashing machine DS 2501eco, used in company canteens and hotel kitchens
  • Agricultural and forestry machinery 134%, for example a Claas Trion 700 combine harvester
  • Electronic data processing equipment (103 %)

compare with the mixed index:

Varios equipment in comparison

Varios equipment in comparison

Fun fact: Electronic data processing devices (computers! tablets!) never actually become more expensive, only the performance increases. The Apple Mini 2 desktop has just come out and – despite increased performance – costs 50.00 EUR less than its predecessor, which is sitting on my desk…

This becomes even clearer in the case of mixed operations.

The price development of process plants, such as distilleries, chemical producers or pharmaceutical companies, cannot actually be represented with a mixed index.

This already starts with companies that are supposedly easy to classify.

One of our clients is a printing company. The performance of printing presses is actually no different from that of standardised commercial machinery (118%). However, our company has exceptionally large extraction and reprocessing systems for the printing inks. These plants have developed quite differently in terms of price (104%).

Price development printing company

Price development printing company

Juice producers have extensive bottling, capping, labelling and packaging facilities (120.2%). But they also have extremely extensive tank farms (143%) and process plants (123%).

Price development juice producer

Price development juice producer

In addition, all these indices are calculated as a ready-to-deliver product, i.e. without freight, packaging and assembly. However, especially in the case of extensive process engineering plants, the assembly work quickly amounts to 30-40 % of the total value of the plant.

This means that wage developments (assembly), packaging prices and freight costs are also decisive for the representation of the new values of a complete plant.

Costs for freight, packaging and assembling

Costs for freight, packaging and assembling

So you should keep an eye on where the focus of your own machines is and make a weighting!

4 Pitfalls in the application of value added clauses

It can be seen that with the help of correctly calculated surcharges, the sum insured can be updated fairly accurately.

Nevertheless, there are a few pitfalls that need to be avoided:

1. The sum insured and the value adjustments must be correct

If the worst comes to the worst, you as the policyholder have to prove that the basic sum and the value adjustments were calculated correctly at the beginning of the insurance. (This makes sense immediately, because if the basis is not correct at the beginning, a correct result at the end would be pure coincidence).

The insurers are strict: only if the value adjustments and the sum insured have been determined correctly will the value adjustments be recognised in the event of a claim.

If you commission us as experts to do this, the ball is in our court!

And: If you submit an expert report, you will even receive protection in the amount of twice the value adjustment.

This means that your sum insured increases without costing you any additional premium.

For example, you can pay “sprinter premiums” to your machinery supplier and, most importantly, you are even better protected against inflation during the year.

2. Inventory changes must be properly maintained

Inventory changes, i.e. additions and disposals, must on the one hand be recorded correctly. On the other hand, they must also be entered into the sum insured with the correct value supplements.

3. Buildings and furnishings must be correctly delimited

Because of the different price development, the correct differentiation between buildings and furnishings is important – in spite of the sum adjustment! – is important. Incorrect allocations lead to incorrect insurance values.

Practical tip: We have written a detailed article on the topic of delimitation of buildings and fixtures and fittings, which you can find here.

4. Do not rely on asset accounting

In the case of expansion, reconstruction and extensions as well as subsequent acquisitions to already existing assets, subsequent production costs arise. For tax purposes, these costs are capitalised and added to the original acquisition costs. However, this means that they are recorded with an incorrect year of acquisition. This can lead to high insurance values when extrapolating on the basis of asset accounting.

Do you have any questions or do you need correct value adjustements for your industrial property insurance? Give us a call, we’ll be happy to help!

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Philip Merker Expert for the appraisal of machinery and technical equipment

Philip Merker, MBA

Certified expert for the evaluation of machinery and technical equipment (DIN EN ISO / IEC 17024)

Mönckebergstraße 5, 20095 Hamburg

Telephon +49 40 602 13 33
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