It's testing time for Indian consumers. Amid a sluggish economic growth and persistently high interest rates, the need to manage monthly budgets without compromising on essential amenities remains a daunting task. Even as one continues to face the challenge of rising cost of food items, another area which witnessed a price increase recently was motor insurance third party premium. As per the new guidelines, third party motor insurance premium, which forms an important component of your vehicle's comprehensive insurance policy, has undergone an increase of 20% for private cars, 10% for Two Wheelers and 10% for Commercial Vehicles.

Comprehensive insurance policy comprises two covers - Own Damage (OD) and Third Party. OD covers loss or damage to vehicle against accidental damage, natural calamities and man-made calamities whereas Third party cover protects the insured against liability due to accidental damages resulting in the permanent injury or death of a person, and damage caused to the surrounding property. For premium computation, Insured Declared Value (IDV) is considered for calculating OD premium whereas Third Party premium is tariffed as per the vehicle category and has no relation to the IDV of the vehicle.

Even though premium rates have increased, there are ways to reduce your motor insurance premium i.e. on the OD component. One can avail NCB benefit, buy anti-theft devices, opt for voluntary deductible, etc to avail premium discount. However, at times, some customers tend to adopt not so favourable means to reduce the insurance premium. This includes declaring or unknowingly accepting a lower Insured Declared Value (IDV) of the vehicle. IDV is central to deciding the insurance premium of your vehicle be it a sedan, two-wheeler or SUV. A lower IDV may help reduce your motor insurance premium but can lead to significant loss in case of intimation of the insurance claim.

Let's understand the concept of IDV in detail. IDV is considered to be the Sum Insured and is fixed at the commencement of each policy period for each insured vehicle. IDV is arrived on the basis of manufacturer's listed selling price of the brand and model, as the vehicle proposed for insurance at the time of commencement of insurance / renewal and then is adjusted with the standard deprecating rates as per Indian Motor Tariff. IDV is the maximum amount that insurance company will pay in case of a claim i.e. in the event of total loss (the vehicle is no longer capable of running on the road), constructive total loss (aggregate cost of retrieval and/or repair of the vehicle is greater than 75% of IDV) or your vehicle being stolen.

For e.g. - If your vehicle value or IDV is fixed for Rs. 4 lakh at the commencement of the policy, the maximum amount the insurance company will compensate you in case of total damage to vehicle or theft will be Rs. 4 lakh. It is important to note that compensation is given only in case of total loss, constructive total loss or in an event of theft of the vehicle within the policy period.

The rate of depreciation keeps increasing with the age of the car. A new car will fetch the maximum IDV but as the vehicle turns old, the rate of depreciation keeps increasing. To cite another example, a car not exceeding 6 months might be charged 5% depreciation rate whereas a car aged between 4 years will push the depreciation to 40%. The rate of depreciation is arrived based on a standard metric (on the basis of age of the vehicle). If the car is more than 5 years old or is an obsolete model (i.e. model which the manufacturer has discontinued to manufacture) is determined on the basis of an understanding between the insurer and the insured.

It is to be noted that at the time of first purchase as well policy renewal, current selling price of the brand and model is considered for computation of IDV and not the price at the time of purchase of the vehicle. For e.g. - if a customer purchase a particular brand and model vehicle in Apr'12 at Rs. 10 lakhs and the current (Apr'14) selling price of the same brand and model is Rs. 11 lakhs; the insurance company would consider the current listed selling price i.e. Rs. 11 lakhs for computation of IDV.

If one declares a lower IDV than the reasonable market value and were to make a claim for total loss, one would receive a lower claim amount since the IDV declared was lower. A little saving on the premium by declaring a lower IDV can thus result in much higher loss in an unfortunate event of a large claim or theft of the vehicle.

At the same time, some customers tend to declare a high IDV assuming that the claim amount will accordingly increase or it can help them if they were to sell the vehicle in the market. However, it must be noted that IDV is the maximum possible claim amount that the insurer will provide depending on the type of loss. At the time of claim processing, the insurer will consider the age of the vehicle and hence its depreciation before finalizing the claim. As such, one may end up receiving a lower claim amount despite having taken a higher IDV and hence paid a higher premium.

So, the next time you renew your vehicle insurance, make sure that the IDV declared is in sync with the vehicle age and model.