As we all are aware that valuation exercise is carried out for various purposes & is normally being done under the following circumstances:

• To ascertain the intrinsic value of assets
• For disposal of assets
• Wealth Tax purpose
• Takeover of assets
• For improving upon the net worth of company
• For Insurance purpose
• To avail loan from Bank after mortgaging the property.

However, we are generally involved in the valuation exercise for the purpose of insurance only.

Need For Valuation

• Correct Valuation Exercise is essential for Insurance because of presence of “condition of average” under all the policies.
• Though some waiver is provided under few specific policies, but Condition of average is normally applicable in almost all the policies.
• Over Insurance does not reward one but under-insurance does penalize. Hence, it is pertinent that we implement correct valuation of assets for the purpose of insurance. It need not be exact but should be correct.

In the earlier days, there was a practice by the Insured to maintain the sum insured as per the depreciated value appearing in their books of Accounts, but now-a-days with increased awareness about insurance, most of the industries and/or corporate have realized its importance. The credit also goes to the brokers, who have been playing a significant role in creating awareness among their clients and/or Insured and cautioning them to get the correct valuation of the property to be done to avoid any loss on account of under insurance at the time of loss.

The valuation for the purpose of insurance is generally performed on reinstatement and/or replacement values of assets such as building, plant & machinery (P&M), Furniture Fixtures Fittings (FFF), Lease hold Improvement, office equipment, computers & accessories etc., which demands plethora of inputs & verification of various aspects (tangible & intangible) before arriving at the re-instatement value of the property.

Since valuation is a very vast subject, I will brief you with the methodology to be adopted while carrying out the valuation exercise for buildings only.

Building Valuation:  There are three basic methods for Building Valuation: –

1. Actual Bill of quantity: It is the best and most accurate method to arrive at the actual value of the property on a particular day. To ascertain the actual quantities of different items (mainly steel & cement) which were consumed at the time of construction and additional quantities consumed during subsequent addition/modification etc. has to be taken out from the records and worked out the reconstruction cost after applying present rates on the same.

But this method has certain limitations such as it is a very lengthy exercise & consumes a lot of time, genuineness/dependability of the documents is also doubtful etc. This problem is more intricate when the plant is very old, and the original drawings are not traceable. The reliability of the books /records is another issue when the plant is purchased from a third party since the capitalization of the secondhand assets is booked by the Insured in their records on depreciated value and/or secondhand purchase value.

1. Plinth Area: This technique is reasonable but cannot be taken as absolutely correct. In this method, the plinth area of the building is multiplied with the prevailing rate of construction on per square feet basis in the area where it is located. It is a short-cut method and simply gives an indication that the cost of construction of the building will be in close vicinity to the value which is also subject to get changed with alteration in the specifications of the building & its location.
2. Indices Method: It is considered nearly correct since the original cost is escalated based on the inflationary indices. The only precaution one has to take is to remove/adjust onetime pre-operative expense while working out the original cost spent on the building. The escalation factor is matter of questioning, but CPWD rate gives nearly a true reflection in construction cost. CPWD publishes indices which are worked out based on the cost of the certain items used in the building (i.e. steel, cement & labour). The index is arrived on the basis of the average cost of the commodity prevailing in various state of India. Though, it is quite possible that some of items could have escalated more than the indices taken by us, but on the same side, it is also true that prices of some of the items might have fallen. Since insurance of building is taken on overall basis, in my opinion the valuation by escalation is the correct criteria & is also internationally accepted norm. In our opinion, indices method is usually most acceptable method for the purpose of insurance.