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Do You Really Need Full Replacement Insurance on Your Current Building?

The owners of a new company bought a building that was used to manufacture aircraft during World War II. The new owners were in the software development business and the building was larger than it needed, but the price was right. However, the property insurance bill surprised them.

Insurance companies base limits of insurance on the cost of replacing a building exactly as it was before the loss. This old building had a replacement cost much higher than both its purchase price and that of other suitable properties. The owners did not need that much insurance, so they asked their insurance agent for alternatives. What if, they asked, we don't rebuild our building as it was?

Many owners of older buildings ask this question. After a building is destroyed, its owners may decide not to rebuild or to replace it with a similar structure for several reasons.

- As was the case with the software company, the current building's design may be impractical. If the company were to rebuild, it would almost certainly choose a smaller building with a different layout.

- Also, old buildings often include materials that builders do not commonly use today, such as plaster and lathe. Reconstruction with these materials is expensive and often unnecessary for the continued operation of the business.

- The company may decide to consolidate the operations of two locations into one. The second location may have the capacity to absorb the first one's operations, and management may feel that it will gain efficiencies by consolidating.

- Depending on the building's age, it may not meet current building codes. The local government may require any new buildings to meet expensive new codes.

The standard business property insurance policy states that the insurance company will pay "actual cash value" - the cost of replacing the property minus depreciation. However, it offers the option of valuing a loss at replacement cost without deduction for depreciation. A business that chooses this option will need to purchase the amount of insurance equal to the cost of replacing the building "as is." It will receive this amount if it rebuilds or replaces the building within a definite period of time. Otherwise, the insurance company will pay the actual cash value.

Businesses that do not need an exact replacement of their current buildings should ask their insurance agents about "functional building valuation" coverage. It sets a limit of insurance somewhere between actual cash value and full replacement cost and allows the property owner to replace the building with one that fulfills the same function as the old one at a lesser cost.

The standard functional building valuation policy form also provides "ordinance or law coverage." This insurance covers the lost value of undamaged parts of the building that must be demolished under local codes; the cost of demolition; and the cost to rebuild in compliance with local codes.

With the right attention to detail, a business can get the property insurance it needs without having to waste money on unnecessary coverage.

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