Business owners sometimes overlook one of the most important aspects of their property insurance. The details and nuances of coverage are important – the devil is in them – but one should never miss the most obvious: the stated amount of coverage. Hidden risk can be concealed within it.
Insuring a building up to its full value is a foundational assumption of insurance. Upon it, the rest of the policy is built. Because of this, penalties exist should inadequate coverage be carried. These penalties apply to commercial buildings, contents, equipment, inventory, stock, and even business income. All forms of property insurance are affected.
Insuring to Value
“Insuring to value” means that the amount of insurance purchased is adequate to replace the lost property, plus satisfy any other policy requirements such as the co-insurance section (see below). This usually means insuring property up to the full cost to replace it, but other property insurance valuation methods exist.
Inadequate insurance to value can cause unexpected consequences. Policyholders sometimes under-insure on purpose to reduce expenses or by believing they will still receive the full value of their insurance policy when a claim occurs. Because insuring to value is a foundational assumption of insurance, it affects how claims are paid.
Co-insurance
The co-insurance section of an insurance policy is an incentive to carry adequate insurance. Most commercial property insurance policies contain a co-insurance section. This section outlines how a reduced settlement will be paid if the policyholder does not carry sufficient coverage.
Co-insurance commonly requires clients insure up to at least eighty percent of their property’s replacement cost. If not, claim payments will be reduced. To be clear, even though a building may be insured for $100,000, if that value does not satisfy co-insurance, claim payments will be less.
Calculation Example
- Co-insurance required as stated in the policy: 80%
- Cost to replace the building: $150,000.
Note: Based on the co-insurance requirement, this means the client needs to insure the building for at least $120,000 to avoid a penalty ($150,000 x 80% = $120,000). - Insurance carried on the building: $100,000
- Claim amount: Assume a total loss to the building, so $100,000.
Formula
- Claim Payment = ratio of under-insurance times the claim amount.
- Claim Payment = (insurance carried / insurance required) x claim amount.
- Claim Payment = ($100,000 / $120,000) x $100,000
- Claim Payment = $83,333
In this example notice how the effects of under-insuring business property multiply. Not only did the client carry $100,000 of insurance for a building that needed $150,000, but their claim payment is reduced as well. Adding these two factors together means that, although they now need to replace a $150,000 building, they will only receive $83,333 to do so!
Blanket Property Policies
For those clients who insure using a blanket property policy, do not become lulled into a false sense of security. Although blanket property insurance provides a degree of protection by considering the value of all properties together, it usually includes a co-insurance requirement of 100%. This means, to avoid a claim penalty, the total amount of property covered by the blanket policy cannot be under-insured even a fraction.
The goal of insurance is to enable the client to rebuild to where they were before a loss. Under-insuring a building or property runs counter to that goal. Your agent can advise regarding how to insure to value. Please contact us with any property valuation questions. Not a client of ours? Let us compete for your business! Each client is assigned a personal agent in our office, given their email address, and provided a phone number that rings right on their desk.