Question

When you bought your business, a complicated custom-made packing machine was included in the sale. You believe that if the packing machine were destroyed that it would cost you $125,000 to replace. You are looking to change your property insurance and the new insurance agent is relying on you to provide a value for the packing machine. You are considering two options. One is to purchase a policy that insures your machinery for $50,000. You figure this will lower the premium and it will save money on your insurance bills. Frankly, you doubt the machine will fail anytime soon. The other option you are considering is insuring your machinery for $200,000. You figure if you get this policy, you will pay more for the insurance, but if your machinery is destroyed, you will not only get back enough money to purchase new machinery, but a $75,000 bonus to boot. For both of these options, what kind of payment do you think you would receive if your machinery is destroyed and the actual value of your machinery is established?

Answer 1

Option 1:- Policy insuring the machine for $50000. This will reduce the premiums. However, it is doubted that the machine may fail anytime soon.

Option 2:- Insuring the machine for $200000. In case machine is destroyed, money will be received to replace the machine and $75000 additionally.

Further, originally if the machine is destroyed, the replacement cost is $125000.

In case of option 1, if the machine is destroyed; the replacement cost will be $125000 and insurance amount of $50000 will be payable. Net of ($125000+$50000=$175000) will be the cost in my hands. No amount is receivable.

In case of option 2, if the machine is destroyed, the money receivable is replacement cost $125000 plus $75000 bonus; net $200000. The cost of taking this insurance policy is $200000. Hence net amount is NIL ($200000-$200000)