Re: Ins claim & co have asked for "a contribution towards the embetterment of the car
I think the insurance company are making a case for improving the car by fitting a new engine.
Their case may be that a 3.5 year old car with x miles should have an engine of a corresponding age and mileage. If a a brand new engine with zero miles is fitted, the car is more valuable / improved.
Insurance policies are there to ensure a policy-holder is not out of pocket, they are not meant to give the policy-holder a "profit" as in your case.