Insurance to value is the “ratio of the amount of the insurance to the value of the property,” according to property insurance expert Robert B. Holtom. When considering the value of your commercial real estate, you should choose the right number to keep your insurance premiums reasonable while guaranteeing any building loss that happens will not force you to pay out of pocket. Your insurance broker does not choose this number for you; determining your property’s value is up to you.

Why You Must Choose the Correct Insurance-to-Value Number

What is your building’s property limit or insurance value? The market value of your building – what someone would pay you for the property in the current real estate market – is not the amount you choose as your building’s property limit or insurance value. Your assessed value, the amount your local tax assessor uses to tax the property, is not the insurance value to pick, either. For insurance underwriters, only the replacement cost value of your property – the amount it would take to rebuild the property with comparable quality materials – matters to insurance companies. It should matter to you, too, because if you choose the wrong number, you may find that even after a partial loss, you will not be able to completely repair or rebuild the property.

Determining Replacement Cost Values

Since the replacement cost of a commercial building is not its market value or its assessed value, how do property owners determine the replacement cost of their buildings? An insurance appraisal may be the safest way to estimate the cost to repair or replace your property. However, short of a paying an appraiser, here are factors to consider when determining your building’s value.

Direct and indirect costs – Direct costs equal the materials and labor needed to reconstruct the building in a like manner with similar quality materials. Indirect costs include permits, architectural costs, consulting fees, engineering input and other costs not directly related to the structure’s site development and rebuilding.

The facility’s age – The older the building, the more likely it is that you will need upgrades for outdated building materials and equipment. These two issues alone can greatly increase costs.

Building code upgrades – Older buildings often need many code upgrades that can increase rebuilding costs. These include complying with the Americans with Disabilities Act, plumbing upgrades, energy efficiency, sprinkler system requirements and other improvements to comply with building and safety codes.

Site accessibility – If the building is at a steep location or adjacent to other, neighboring properties, it may require bracing or other safety measures during the demolition or reconstruction. These issues add costs.

Unique or non-typical building characteristics – Historical elements such as stained glass and green rooftops may increase construction costs.

Blanket Property Values or Agreed Amount May Help Avoid Underinsurance

Consider a commercial real estate organization that has fifteen properties within a relatively close geographic area. “Specific limit” assigns a replacement value to each individual building at each location. The specific limit is the most the insurer will pay after a loss to repair or replace any one building. Alternatively, a “blanket limit” can apply to all property at the same location or at all the different property locations. Using blanket limits, you can choose a blanket limit for your building and its business personal property; a separate blanket limit that applies to each location; or a single blanket limit that applies to all locations. Blanket limits cost more than specific limits, and most insurers will insist you insure the total value of your properties to 90% of the insurer’s estimated replacement values.

Important Points to Consider When Choosing a Property Insurance Value

Here are some tips tips to consider when choosing an insurance value on commercial habitational properties. First, don’t think “replacement cost.” Change that thought to “reconstruction cost,” because it always costs more to rebuild something already there (think demolition and removal costs) than to build something new. Remember that it may be impractical to use the same methods or materials to rebuild your commercial building, so the cost to reconstruct your building may be significantly more than you might estimate. Building owners must also factor in any problems associated with coinsurance, as well.

Next, always consider that current market conditions will increase material and labor costs. For example, after Hurricane Harvey in Houston, soft lumber prices shot up by 22% and oriented strand board increased 33%, according to Builder. Labor costs rose rapidly, as well.

Finally, review your policy for any difference between your valuation and the policy limit. Also assess any limiting language in the policy, including the use of a margin clause or a per occurrence limitation of liability provision. Either of these can limit the amount a property owner can recover after a loss to a specific percentage of the stated value of the property, for example 110% of the location’s reported value.

Most losses are partial, so the problem of replacement cost values may be one most commercial habitational property owners will never face. If you do face an underinsured-to-value issue on a total loss, however, you’ll need a sedative once you understand the amount of money you will incur out of pocket, in addition to your deductibles. This can impact your profitability or in some cases, make rebuilding impossible.

Insurance to value on commercial habitational policies is a complex issue for property owners. We’re always happy to discuss valuation with you. The time to consider your portfolio’s insurance to value is before a loss, not after one.