Insuring used machinery in transit

Used/ second-hand machinery/equipment in transit are perceived as inferior risks, and rightly so. Reasons are not far to seek — 1) The actual condition of the machine/equipment prior to transit, is not known. 2) The possibility of a thin dividing line between fortuity losses and wear-and-losses or fortuity losses getting aggravated because of the age of the machine. 3) OEM packing for the used machine may not be available. 4) Valuation always presents an issue. We focus here on Point 4 only.

Any marine underwriter worth his salt would immediately add the Institute Replacement clause in his quote/slip, when it comes to machinery in transit. The original version, CL 161 of 1/1/34 (yes, 90 years old and even prior to the Institute cargo clauses), reads as under:

” In the event of loss of or damage to any part or parts of an insured machine caused by a peril covered by the Policy the sum recoverable shall not exceed the cost of replacement or repair of such part or parts plus charges for forwarding and refitting, if incurred, but excluding duty unless the full duty is included in the amount insured, in which case loss, if any, sustained by payment of additional duty shall also be recoverable.
Provided always that in no case shall the liability of the Underwriters exceed the insured value of the complete machine.”

This clause serves the purpose when a new machine/equipment backed by a formal invoice/valuation is moved from one location to another. What this clause seeks to say is that, for any loss/damage to part/parts of the machine, a Total Loss/Constructive Total loss cannot be claimed. The amount payable by the insurer will be the cost of part/parts, forwarding, removal/refitting charges, repairs, if any, customs duty, if included in the sum insured. The outer limit will, of course be the sum insured under the policy, that would be payable in case of Total loss too. The question of deduction towards depreciation does not arise, as the insured machine is new.

Issues on valuation arise when a machine that is not new, but a used one. is being moved:

a) What should be the basis of arriving at the sum insured? Original purchase price, Current market value of the machine or its new Replacement value?

b) In the event of a partial loss of parts plus repairs, will depreciation be applicable based on the age of the machine? If there be a Total loss, will the sum insured (howsoever arrived at, as stated in (a)) be paid?

Let us have a look at the common wording in vogue in the Indian market for covering movements of second-hand/used machinery:

REPLACEMENT CLAUSE SECOND-HAND MACHINERY
“In the event of loss of or damage to any part or parts of the goods insured in
consequence of a risk covered by the policy, the amount recoverable hereunder shall not exceed such proportion of the cost of replacement of the part lost or damaged as the insured value bears to the value of new machinery, plus additional charges for forwarding and re-fitting the new part or parts if incurred.”

This is broadly based on the Institute Replacement clause- Proportional Valuation- CL 373 of 01/12/2008, whose wordings read:

“In the event of loss of or damage to any part(s) of an insured machine or other manufactured item consisting of more than one part caused by a peril covered by this insurance, the sum recoverable shall not exceed such proportion of the cost of replacement or repair of such part(s) as the amount insured bears to the new cost of the machine or manufactured item, plus labour for (re)fitting and carriage costs. Duty incurred in the provision of replacement or repaired part(s) shall also be recoverable provided that the full duty payable on the insured machine or manufactured item is included in the amount insured.
The total liability of Insurers shall in no event exceed the amount insured of the machine or manufactured item.”

Does CL 373 address both the questions raised under (a) and (b)? There is no explicit mention of depreciation, either in case of a partial loss or total loss. It only says that in case of a partial loss, the amount recoverable will be the actual expenses incurred, BUT in the proportion of the sum insured to the new replacement value of the machine. For instance, if the total expenses incurred for repairs be INR 100, the machine insured for INR 1000 and its new replacement value is INR 1500, amount payable as claim will be 100 x 1000/1500. The wording also mentions that the total liability of the insurer will not exceed the sum insured. So, in case of a Total loss, the sum insured, howsoever arrived at, will be payable.

One fair conclusion, we can draw from the CL 373 wording is that unlike in case of a Machinery Breakdown insurance, there is no compulsion to insure for New Replacement value. On the contrary, underwriters should be mindful that an unscrupulous assured does not insure his used machine for new replacement value (as premium rates are low, a much higher sum insured, hardly matters), and in case of a Total loss, claim the full value of a new machine — New for Old, as the value insured will be the same as the new replacement value of the machine.

What is happening in practice in the Indian market today? Every slip from brokers carries a requirement for covering used/second-hand machinery. Emphasis is on exemption from pre-dispatch inspections with little focus on the valuation of used machinery. Similarly, insurers too, do not pay attention to the valuation aspect of used machines, but merely add the Second-Hand Replacement clause to the policy. Some insurers do insist on separate monthly declarations of machinery movements, but still the valuation is questionable. Look at it from the assured’s standpoint. Often, the books of accounts show block-wise values of plant and machinery, rather than value of each machine separately. Do they obtain insurable values by comparing with quotations for new replacement values, etc? No. Only God knows, how the value insured is arrived at. To be fair to insurers too, they just cannot check if someone is actually insuring for new replacement value in a bid to get ‘New for Old’ in case of a loss.

Partial losses in machinery are more frequent than total losses. So, what can be a fair arrangement, where an assured gets his claim for actual expenses incurred in case of a partial loss, without depreciation, if he has insured for new replacement value AND the insurer pays only the market value of the machine in case of a Total loss, despite it being insured for new replacement value? Possibly add a manuscript condition to this effect, replicating the wordings in a Machinery Breakdown policy? A machine whether in operation or in transit, should be subject to the same set of rules on valuation, don’t you think? The current wordings used and the treatment in case of claims, leaves much to be desired. I have come cross cases, where loss assessors have straightaway applied depreciation for machines damaged in transit, without confirming values insured and new replacement values.

High time, the industry looks closely at issues plaguing used machinery in transit, especially the valuation and depreciation aspects.