Unfortunately, people tend to underinsure and consequently have inadequate policies. We urge you to spend a little extra time to ensure this number is correct. This process will require some forethought, research and even some educated guesswork, but the payoff will be a commercial property insurance policy that is structured to help protect your business’ viability.
Replacement Cost or Actual Cash Value?
When determining how much commercial property insurance to carry on your building, you need to decide what type of policy you need. Your options are “replacement cost” or “actual cash value” coverage. In the event of a loss, your coverage should be enough to either rebuild (replacement cost coverage) or purchase a similar building at another location (actual cash value coverage). Here are some additional factors to consider:
- Replacement cost – This coverage should provide enough money to rebuild with the same features as your current building at your current location. It does not deduct for depreciation.
- Actual cash value – This coverage should provide an amount based on the building’s depreciated or market value, which may be less than the cost of replacing or repairing the property with new materials.
- Suitability and availability – If your building is uniquely suited to your business needs, you may need to replace it with a similar building. If the location of your building is critical to success, you may need to rebuild at the same location. In either case, replacement cost coverage might be best. However, if you could easily continue operating in a similar building at another location, then actual cash value coverage is worth considering.
- Affordability – Premiums are higher and insureds need to carry a larger amount of insurance with replacement cost coverage. If insurance costs are a primary concern, actual cash value may be a better fit.
Once you’ve decided on the type of commercial property insurance coverage that best suits your needs, it’s time to calculate the property value for your policy. It’s important to determine how much would be needed to replace the building with the same materials and features at current construction costs (this does not include the land’s value). To obtain the most accurate number, we suggest the following:
- Hire a qualified professional to perform a building appraisal. Your insurance representative should be able to provide recommendations or referrals to qualified commercial real estate appraisers.
- Use a replacement cost estimator. Most major insurers have a replacement cost estimator that allows you to input your building’s information (such as square footage, construction type and any unique features) and it provides an estimated replacement cost. You can also purchase a program and perform the estimation yourself.
- Consult a local contractor. While information from a contractor is helpful, it’s important to remember that they are usually building from “scratch.” The cost for new construction is generally less than the cost to rebuild.
It’s also important to factor in this list of expenses:
- Debris removal costs
- Architect / designer fees
- Cost inflation for building materials and labor
- New building codes
Keeping Up with a Changing Market
Real estate values and rebuilding costs constantly change, so we suggest reviewing your insured property value each year at renewal. An active construction market has steadily increased building and material costs, so it has become even more important to regularly update your commercial property insurance policy. Consider Turner’s latest Building Cost Index, which measures the costs in the non-residential building construction market. The Second Quarter 2018 experienced an increased index value of 1089, a 1.68% quarterly increase from the First Quarter 2018 and a 5.63% yearly increase from the Second Quarter 2017.
An Advocate for Your Business
Commercial property insurance is a vital part of your business. Due to the nature of the construction industry, this policy can’t be a “set it and forget it” thing. Working with industry experts who understand your exposures can help protect your business in the event of a claim. Having accurate replacement cost values established is the best way to ensure your company will survive a major loss. If you’re in need of assistance, the professionals on our Real Estate Risk Services Team are ready to help.
This article originally appeared in the 2018 | ISSUE TWO of the SilverLink magazine, under the title “Is Your Policy Enough | Commercial Property Insurance?” To receive a complimentary subscription to the SilverLink magazine, sign up here.