Do You Need Full Replacement Coverage for Your Commercial Property?
The owners of a new company found a building on the market for an affordable price, so they bought it. Built in the 1940s to manufacture aircraft for the war effort, the metal structure had a large open space.
The company occupying this space was in the software development business and the building was much larger than it needed, but the price made it seem like a sensible move.
However, the owners got a surprise from their insurance agent about property coverage. Insurance companies base limits of insurance on the cost of replacing a building exactly as it was before the loss. The cost of reconstructing this old building was much higher than both its purchase price and that of other suitable properties.
The company did not need that much insurance, and paying the higher premium for it would have been wasteful, so the owners asked the agent for alternatives. What if, they asked, we don't rebuild our building as it was?
After a fire or some other catastrophe destroys a building, its owners may decide not to rebuild or replace with a similar structure for a number of reasons.
• As was the case with the software company, the current building's design may be impractical. The company bought the building because of a good price, not because of its large open space. A software developer ordinarily does not need that much space; if it were to rebuild, it would almost certainly choose a smaller building with a different layout. Also, very 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 an amount for depreciation.
But 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."
The company will pay the difference between the actual cash value and the replacement cost only if the property owner actually rebuilds or replaces the property, and then only if he does so as soon as reasonably possible after the loss.
The policy also provides a small amount of additional insurance (typically the lesser of 5% of the insurance on the building or $10,000) to cover the increased cost of construction resulting from changes in building codes.
Your options
If you feel that your business does not need an exact replacement of its current buildings, you should ask us about adding a "functional building valuation" endorsement to your policies. It establishes 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.
Our discussion with you should also include increased "ordinance or law" coverage to provide additional insurance for increased costs from new building 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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