What Does Sum Insured Mean?
Sum insured is the amount of money that an insurance company is obligated to cover in the event of a covered loss. This term is commonly associated with homeowner's or property insurance but can also apply to other types of insurance.
The sum insured correlates directly to the amount of premium you pay, but not always to the property's actual value or asset insured. If the sum insured is less than the replacement value or required amount to rebuild, it is often referred to as underinsurance.
It is common practice in almost all areas of insurance that compensation is based on the new replacement value in the event of a loss. This means the amount of compensation is enough to fully replace or restore the items to the new condition. The cost of these new items would need to be of identical type, quality and condition.
The purpose of this is to allow the policyholder to feel as if no loss has happened. This is often misunderstood as there are many different terms and levels of replacement value and calculation within the insurance industry.
Three of the main types of sum insured calculations are:
New replacement value (NRV).
The actual cash value refers to the value of the item at the time of loss. This value is calculated by deducting an amount based on the usage, age and condition of the items. This is referred to as depreciation. The value is intended to allow for the replacement of the item with an item in similar condition. Often, insurance companies will have percentages used as a threshold of when it is better to use the new replacement value.
The third term, which is similar, yet different is the fair market value. This is the amount that you would presumably get for the item if you were to sell it. This amount does not use percentages or set amounts but is set by the market conditions or prices. The replacement cost type can directly impact the sum insured and premium amount charged, which can often be decided upon by the policyholder at the time of purchase.