Your Building Is Insured for $1 Million. What If It Costs $1.4 Million to Rebuild?
Imagine you own a commercial building in Cumming, Georgia and it’s insured for $1 million. After a major fire, the building is a total loss.
Then the estimates start coming in.
Between materials, labor, debris removal and today’s construction costs, rebuilding the property is expected to cost $1.4 million.
So, does your insurance company just pay the extra $400,000?
Not necessarily.
A commercial property policy’s building limit matters, and one of the worst times to discover that the limit is too low is after a major loss.
Your Building’s Market Value and Rebuilding Cost Are Not the Same Thing
One of the first misconceptions to clear up is that the amount your building is insured for does not necessarily need to match what you paid for it or what you could sell it for.
Those are different numbers.
A property’s market value can include the value of the land, location and local real estate market. Replacement cost is concerned with something different:
What would it cost to reconstruct the insured building after a covered loss?
That can include current labor and material costs, contractor expenses and other costs associated with reconstruction.
A building in Gainesville, GA could have a market value of $900,000 in Gainesville, GA but cost $1.2 million to rebuild. The reverse could also be true.
For insurance purposes, understanding the estimated reconstruction cost is critical.
What Happens If the Building Limit Is Too Low?
Suppose the replacement cost of your building is $1.4 million, but your policy only carries a $1 million building limit.
If a covered loss destroys the entire building, you should not assume that the policy will automatically provide the additional $400,000 needed to rebuild.
Exactly how a claim would be handled depends on the policy, its valuation provisions, endorsements, applicable deductibles and other terms. Some policies may include additional protection such as extended replacement cost or other enhancements.
But the basic problem remains:
If the building costs substantially more to reconstruct than the amount of insurance available, the business owner could be left with a significant gap.
And underinsurance can potentially create problems on partial losses too.
Don’t Ignore Coinsurance
Many commercial property policies include a coinsurance requirement.
A common example is an 80%, 90% or 100% requirement that is tied to the value of the property.
The important part for a business owner isn’t memorizing the formula. It’s understanding the consequence:
If your property is supposed to be insured to a certain percentage of its value and you carry significantly less insurance than required, a covered partial loss may not be paid the way you expected.
That means being underinsured isn’t only a concern when the entire building burns down.
Your agent should be able to show you whether your policy contains a coinsurance requirement, what percentage applies and how your current building limit compares with the estimated replacement value.
Building Codes Can Make Rebuilding Even More Expensive
There is another issue that can surprise owners of older commercial buildings.
Imagine a fire damages a large portion of a 30-year-old building. You plan to repair exactly what was damaged, but current building codes in most of North Georgia require upgrades to electrical systems, plumbing, accessibility features or other portions of the property.
Those additional costs may not simply fall under ordinary building replacement coverage.
That’s where Ordinance or Law coverage can become important.
Depending on the policy, this coverage may help address costs associated with things such as:
- The undamaged portion of a building that must be demolished
- Demolition expenses
- Increased construction costs required to comply with current codes
The appropriate limits depend on the building and policy. Simply having Ordinance or Law coverage listed is not the same as knowing the limits would be adequate for your property.
Rebuilding the Building Isn’t the Only Problem
There is one more question a business owner should ask:
How long will the business be unable to operate?
A serious property loss can create two financial problems at the same time:
- The cost of repairing or replacing the property
- The income the business loses while recovering
A manufacturer might be waiting on machinery. A restaurant could be closed during reconstruction. A medical office may need temporary space. A retailer could lose months of revenue.
That’s why Business Income and Extra Expense coverage should be part of the property conversation.
Having enough insurance to reconstruct the building doesn’t automatically mean you have enough protection to keep the business financially healthy during the reconstruction.
What Should a Business Owner Review?
You don’t need to become a commercial property insurance expert.
But if you own your building, there are several questions worth asking:
- What is the current estimated replacement cost of the building?
- How was that number determined?
- When was the building value last updated?
- Does the policy use replacement cost or actual cash value?
- Is there a coinsurance requirement?
- Is any extended replacement cost or similar protection included?
- How much Ordinance or Law coverage is available?
- Would Business Income coverage reasonably support the business through a lengthy shutdown?
- Have renovations, additions or major equipment purchases changed the values since the policy was written?
Construction costs can change. Businesses renovate. Buildings get expanded. Equipment gets added.
Your insurance program should not remain frozen while the property it protects changes around it.
The Bottom Line
A commercial property limit shouldn’t just be a number carried forward from last year’s policy.
If your building is insured for $1 million, the important question isn’t simply whether $1 million sounds like a lot of insurance.
The better question is:
What would it actually cost to put your business back where it was after a major loss?
If it has been a while since the values on your commercial property policy were reviewed, we can help you take a closer look at the building limits, valuation, Business Income coverage and other property protections in your current insurance program. Contact us today to review your business insurance policy to make sure that your coverage is current and best fits your needs today.