Almost every business needs some type of property insurance. Whether you own your building, lease a space, or work from home, there is a good chance you are using physical items in some way in your business. According to financial services company Hartford, approximately 60% of the top 10 most common claims are property losses.
The most common risks include theft, and fire, wind, and water damage. Property insurance exists to protect these assets in the event of a loss. Understanding the types of coverage and options available to you will go a long way in making sure your insurance policy is protecting your business properly both in terms of coverage and cost.
Building coverage provides protection for the actual building itself. It can also include a few other specific types of property within so many feet of the premises, depending on the policy wording. To determine the value of the building, the first step is to calculate what it would cost to replace the entire building from the ground up in the event of a loss.
This is done is by running a calculation based on:
- The age of the building.
- Square footage.
- Condition of the building.
While this calculation can vary by insurance company, Marshall & Swift/Boeckh (now under CoreLogic) is a universally accepted calculation software used by the insurance industry and several others.
Once this value is established there are three ways a building can be covered:
The first and most common option that commercial policies provide on property coverage is on a replacement cost valuation. In the event of a claim, the insurance company will pay to replace the building with the same kind and quality of materials as the existing building up to the value stated in the policy.
Another option is to have the limit based on the actual cash value of the building. After the replacement cost is calculated, the age and condition of the building are taken into consideration and a depreciation amount is applied. This is most commonly done for older buildings, buildings under construction, or those in less-than-good condition.
For example, if a building has a replacement cost of $1million, is 100 years old, and needs a little work, the owner may be inclined to insure it for $600,000 assuming about 40% depreciation in that time. In a total loss, the owner would be eligible to receive up to the value listed in the policy. In a partial loss (as the majority of property claims are), it’s a little more complicated as the cost to replace the damage would be calculated and then a depreciation factor is applied.
The third option is a functional replacement cost. This option is commonly used for older buildings. It is similar to replacement cost except instead of replacing materials with “like kind and quality” the calculation considers basic grade alternatives for the building material. For example, instead of replacing the solid cherry pocket doors in the turn of a century building, they will use hollow builders' grade doors instead.
The easiest way to think of contents (also called business personal property) coverage is if you took your building and turned it upside down; anything that falls out is your contents. It includes furniture, fixtures, equipment, machinery, electronics, and more.
Contents coverage can also be paid on a replacement cost or actual cash value basis.
There is some gray area when it comes to large equipment/ machinery and if it should be considered in the building or contents calculation. The easiest test is if it’s bolted to the floor or walls, it can typically be considered in the building limit. However large/ heavy pieces of equipment that aren’t easily movable or fully built-in or secured can sometimes be considered in the building calculation as well. It's an important distinction because generally speaking, building coverage has a lower rate than contents coverage does. The best recommendation is to review those with your agent and/or underwriter in detail just to make sure you’re all on the same page before making any assumptions.
Electronics and computer equipment is another matter to review carefully. Some insurance carriers will consider it all in one lump sum and others break it out as electronic data processing equipment. Since those contents are movable, it’s important to make sure you know what your limit is on-premises and off-premises as those often time can vary. In this new age of remote work, it is more important than ever to be aware.
Stock or inventory is usually considered as part of the contents limit, but can also be a separate limit itself depending on the type of business. If a business only keeps a small amount of raw materials and stock on hand, it’s probably better to combine it with the contents and have one limit. However, if a business houses a lot of stock (a grocery store for example), it’s going to be more cost-effective to have a separate stock limit.
Because these are goods held for sale, they are typically valued at the replacement cost of the items instead of the retail price, although some carriers do have a sales price coverage option. The limit is calculated based on the amount of inventory you typically have on hand. If there are times of year that are busier for you than others, then you can add a seasonal fluctuation endorsement. For example, if you usually have $500,000 in stock 10 months out of the year, but carry $750,000 for the holidays, it doesn’t make sense to pay the premium on that larger amount for the whole year. However, this seasonal fluctuation coverage ensures that if a loss occurs in the holidays you have an additional percentage of coverage on top of the limit in the policy.
Tenants' Betterments and Improvements
Tenants' Betterments and Improvements (TIB) is another coverage that can sometimes be included in contents or specified separately. Any improvements you make to your leased space (walls, fixtures, flooring, etc) are often contractually your responsibility in your lease. Some insurance carriers will include this in the contents coverage and others like to break it out as a separate limit.
TIB can be valued on a replacement cost or actual cash value basis. It is important to review these property classifications carefully with your agent and make sure your exposures are actually covered as you intend them to be.
Most business policies provide coverage for physical damage to property for “special” causes of loss; this is sometimes called an “all-risk” policy. Essentially everything is covered unless it’s specifically excluded. Each policy carefully lists all exclusions and they do vary by insurance company, but common exclusions include earth movement, water damage, nuclear hazards, government action, war, mechanical breakdown, wear and tear, delay/ loss of use, pollution, dishonest acts, and material defects.
Other causes of loss that property policies can be written on are basic or broad. These policies specifically list the exact causes of loss they cover and tend to be used for vacant buildings or rental dwellings.
You can also enhance the policy with endorsements that add coverage back for an additional cost. Earthquake, water backup from sewers or drains, flood, and mechanical breakdown are commonly added to many property policies.
The cost/ availability depends on your geographic location. Earthquake coverage in California is going to be harder and more expensive than earthquake coverage in Ohio. Flood coverage may be available in a low-risk zone and have to be purchased separately for a high-risk zone.
Coinsurance is an often misunderstood term as it does not mean the same thing in a property insurance policy as it does in a health insurance policy. The important thing to note about property insurance is that the insurance company will calculate the value of what limit you should have been carrying at the time of a loss.
So if you bought your building 10 years ago for $1 million and never increased your limit over the years and had a claim, you may assume you’d get up to $1 million for your loss. But, if there is a coinsurance clause on the policy, that may not be the case. If at the time of the loss the adjuster determines the value is actually $2 million and you were only carrying $1 million, you’re only insured at 50% to value.
Most policies with a coinsurance clause have an 80% or 90% insurance to value requirement. So if you were only carrying 50% of the value instead of the required 80%, they will penalize your claim payment. In this example, you’d only get $500,000 for the loss.
If your policy has a coinsurance clause in it, it will be shown on the Declarations Page. The best practice is to ask for no coinsurance or an agreed value endorsement to be added to the policy. This puts you, your agent, and the underwriter all in agreement at the beginning of each policy term as to what the building’s value is and no penalty would apply if it turns out that you should have actually been carrying more.
Review Your Lease Carefully
Always review your lease carefully for what parts of the building you are responsible for. Many leases include HVAC or exterior AC units as the tenants' responsibility. Doors, windows, garages, and electricity can also be considered as the tenants' responsibility.
Some of these are considered building coverages, so if you are only carrying contents coverage, you may not be properly covered. Be sure to review your lease with an independent insurance agent so they can ensure that you're covered correctly.
Consider Creating an Inventory
While not required, creating an inventory for your contents can be a worthwhile exercise. It gives you an accurate idea of what you’ve actually got (things add up quick) and in the event of a loss, it will make the claims process that much smoother. Raizner Law has a great list of basic steps to putting an inventory list together.
While property coverage is not necessarily a "required" insurance coverage, it is an extremely important consideration in protecting the physical assets of your business. Making sure you have a conversation with an independent agent about the details of your property will go a long way in making sure you have the coverage you need at the right price.
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