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Is Your Commercial Property Insured to the Right Value? The Answer May Be an Unpleasant, Costly Surprise

Written by Jennifer Neal on

Commercial property owners take care to insure their buildings against physical damage and business interruption. But if you have not insured your commercial property at the right value, you could end up paying out of pocket for the difference between the policy coverage limits and the actual cost of repairs or reconstruction.

To avoid costly consequences like these, it is essential to insure your commercial property to the right value. However, that is not as simple as it sounds—which is why there is a good chance your commercial property is not properly covered.

Why the Term “Value” Creates Confusion

When insurance carriers write a commercial property policy, they base the premium on insurance-to-value (ITV), which should represent an accurate cost to replace or restore the building after a loss. However, the term “value” can mean different things in different contexts, and that often creates confusion when insuring a commercial property.

For instance, fair market value represents what the property is likely to sell for in the current real estate market, while assessed value is what a city or township assessor values the property at when determining your real estate taxes.

While both are common ways of expressing a commercial property’s value, neither are relevant in determining the value for insurance purposes. When it comes to protecting your commercial property, the only value that matters is the replacement value: the cost to rebuild or replace the property at today’s construction prices. In some cases, the replacement value may be higher than the fair market value or the original purchase price.

To assure your commercial property coverage is sufficient if you suffer a loss, your policy needs to be based on an accurate replacement value. However, that is often not the case.

In the current market, the two biggest factors that increase the odds your property is underinsured are rising inflation and continued supply chain constraints. High material costs, tight materials inventory, high labor costs, and labor shortages all combine to make it more expensive than ever to repair or replace a commercial building. You could purchase a commercial property for $7 million today and find the replacement cost is $8 million only six months from now.

How an Insufficient Property Value Can Cost You

You might wonder how important it is to determine an accurate replacement value when insuring your commercial building. After all, what are the odds you’ll suffer a total loss?

The truth is, total losses are not uncommon. And even if you only experience a partial loss, failing to insure your property to an accurate replacement cost will still prove costly.

While a commercial building constructed of concrete and steel is less likely to be brought down than a wood-and-bricks building, tornados and fires can leave commercial buildings completely devastated. What is more likely is a partial loss, such as wind tearing apart the roof or a pipe bursting after hours and causing significant water damage

Whether your loss is full or partial, if you insure the building for less than the cost to replace it, you could face significant costs. This example illustrates why:

Let’s say you purchased a building for $9 million three years ago and insured it for the purchase price. Each time the policy came up for renewal, you left the property value unchanged. Now, your sprinkler system leaked overnight and caused major water damage. The repair estimates are coming in at $2 million. Since your policy was written for a value of $9 million, you assume all is well. Unfortunately, it is not.

In the three years since you bought the property, material and labor costs have skyrocketed. Today, it would cost $13 million to replace the building you paid $9 million for. Your insurance policy has an 80% coinsurance clause, which means you must insure the property for 80% of its replacement value. But your building is insured for less than 80% of its current replacement cost, so your claims payout will be reduced accordingly.

Given that the building is only insured for ~70% of its replacement cost ($9 million divided by $13 million = 70% in round dollars), your claim payout will only be ~70% of the total estimate. With repairs expected to cost $2 million, you could be left paying $600,000 out of pocket.

How the Right Advisor Can Help

To arrive at an insured value that provides sufficient coverage and avoids costly gaps, commercial property owners need the expertise of a partner that understands the complexities of valuing commercial property. That is where a private insurance advisor like B. F. Saul Insurance can help.

The commercial property insurance specialists at B. F. Saul Insurance each have decades of experience in this industry, across many different types of properties in a wide range of markets. That means we know the importance of insuring a commercial building to replacement value and how to develop an accurate valuation, even in today’s volatile market.

B. F. Saul Insurance works closely with you to obtain the necessary details about your property, then we conduct extensive research on comparable property appraisals and conditions and use sophisticated software to arrive at a starting point for your replacement value. We discuss the proposed value with you and your risk manager to ensure everyone is comfortable with the final number we provide to your insurance carrier.

Of course, it’s important to get the insured property value figure right when you first purchase a commercial property. In fact, many property owners and investors contact B. F. Saul Insurance during the due diligence phase of a real estate transaction so they can gauge the premium cost based on an accurate insured value.

But it’s equally important to keep your insured value current as market conditions change. That is why B. F Saul Insurance thoroughly evaluates your commercial property value every time your policy comes up for renewal, to avoid any unpleasant and costly surprises in the event of a loss.

B. F. Saul Insurance is the trusted partner that commercial property owners turn to for help insuring their buildings at the right value, reducing the risk of surprise out-of-pocket-costs. Contact a B. F. Saul Insurance advisor to arrange a free consultation about your commercial property’s insured value.
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About The Author

Jennifer Neal is a Vice President and Account Executive in B. F. Saul Insurance’s Commercial Lines practice. With over two decades of experience in the industry, Jennifer oversees and manages the commercial book of business and assists with agency policies and procedures. She has spent most of her career balancing the producer and account executive roles, working in commercial lines, employee benefits, and personal lines.

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