Principle of Escalation Clause in Fire Insurance

An escalation clause in fire insurance is a provision designed to empower businesses and individuals, giving them control over their insurance coverage. It protects them from the rising cost of property values and the effects of inflation.

The escalation clause in fire insurance generally includes a percentage rise or increase that is applied to a policy coverage amount each year. This ensures the coverage keeps pace with changing inflation rates or other factors that affect the insured property’s value.

This means that when a policy reaches a threshold limit, the policy limit is instantly increased to a predetermined amount, as per the escalation clause. This offers additional coverage to the policyholder.

For instance, if the escalation clause mentions a 10% increase to account for inflation, the sum insured would be increased by 10% each year.

The clause comes into effect when the expenses incurred in repairing and rebuilding damaged buildings exceed the policy's predetermined limit. So, policyholders have the flexibility to increase policy limits in case of a catastrophic fire, adapting their coverage to the changing circumstances.

This clause in a fire insurance policy not only helps provide adequate coverage to policyholders in the event of a fire but also offers a sense of security and peace of mind.

Knowing how the escalation clause works in fire insurance is crucial. The clause has two crucial factors; triggering events and calculation and adjustment of escalation clauses. Let's understand these factors in detail.

Triggering Events

One of the main factors that affect the escalation clause in fire insurance is the triggering event. The triggering event is the situation that will activate or start the escalation clause, like natural disaster damage, increased repair costs, etc.

The triggering event in fire insurance may vary depending on the policy condition. When the triggering event occurs, depending on the escalation clause, the policy coverage limit will be calculated and adjusted.

Computation and Adjustment

The escalation clause calculation or computation generally depends on the percentage of the insured property value at the time of policy issuance. Let's say, for example, the insured value is ₹1,00,00,000 at the time of policy issuance.

The escalation clause value is set at 15% for the triggered event. So, when the triggered event occurs, the coverage limit will increase by ₹15,00 000 as per the escalation clause condition.

The clause's adjustment comes into effect either at a predetermined interval or in reaction to a trigger event. In some insurance policies, the escalation clause is adjusted annually based on inflation or a variation in the property's value.

Suppose a person X owns a computer hardware company. To protect their business, they have invested in a fire insurance policy to get coverage against damage or loss caused by fire.

While buying a policy, they computed their asset value and decided to go with a plan that offered ₹15,00,000 coverage.

Unfortunately, a fire occurred in the premises due to a short circuit, and property worth ₹30,00,000 was damaged in the incident. Since X has a fire insurance policy, he approached for the claim settlement.

The insurance provider verified the loss of ₹30,00,000, but X has coverage of only ₹15,00,000; the claim was settled accordingly.

However, if X had purchased fire insurance with an escalation clause, the scenario would be different. In that case, the insurance provider will consider the current market value of the property at the time of the claim settlement process.

The escalation clause in fire insurance policy offers significant benefits to the policyholders. Some of the prominent benefits of including an escalation clause in a fire insurance policy are:

Additional Coverage

One of the significant benefits of including the escalation clause in insurance is that it offers additional coverage in unforeseen fire situations. As a result of including escalation clauses, the coverage limit of an insurance policy increases over time.

This will help in ensuring that the insured has adequate coverage for repairing or rebuilding the asset damaged due to fire.

Protection from Inflation

Another significant benefit of including this clause in a fire insurance policy is protection from inflation. Over time, the cost of building and repairing increases due to increased costs of materials and labour.

In such a situation, the coverage amount will also be enhanced, considering inflation. This ensures that the policyholder has the right amount of coverage depending on the current market prices.

In addition to various perks offered by the escalation clause, there are some risks associated with it. Some of these risks are listed below:

• The cost of a fire insurance policy premium will increase over time as the policy’s coverage amount will increase.

• If a policyholder's coverage amount is adequate for rebuilding and repair, then escalation clauses will not offer any additional benefits.

• Besides this, the escalation clause will not offer protection against all types of losses and damages.

Escalation clauses in fire insurance are beneficial for policyholders. Policyholders can adjust the insurance policy coverage amount as per the current market situations such as inflation, material costs, etc. This helps in offering sufficient coverage to the policyholder in the event of a fire.

However, before purchasing fire insurance, it is better to carefully review the policy terms and conditions, how the escalation clause adjustment occurs, and how it will affect the premium to make an informed decision.

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What is the principle of escalation clause in fire insurance policy?

The escalation clause in fire insurance policy offers an increase in the policy coverage in the event of an increase in the cost of rebuilding and repairing due to inflation and other factors.

Is the margin clause and escalation clause in fire insurance the same?

No, both are different clauses. A margin clause allows an increase in the insured amount of the fire insurance policy in the event of increased or enhanced property value due to appreciation and another factor – up to a predetermined amount/percentage of the sum insured.

The escalation clause allows an increase in the insured amount in the event of an increase in the cost of reconstructing and repairing due to inflation and other factors.

The main difference here is that escalation clauses are usually triggered and may be adjusted (subject to policy terms) in the event of a claim, but margin clauses are pre-determined and can not be modified during claims.

Is it necessary to include an escalation clause in fire insurance?

No, an escalation clause is a voluntary offering by the insurance provider. Some fire insurance plans will have it and some will not. The clause’s purpose is to automatically increase the sum insured throughout the policy period, subject to policy terms.