At some point in time as a business owner you have had to decide how much insurance coverage you feel you need on buildings, equipment or stock that you own or are responsible for. Hopefully the following will help you make an informed decision.
Most property insurance polices contain a “Co-Insurance Clause”. The word in essence means that both parties, yourself and the insurance company can become partners in payment of an insured loss. Most insurance claims to buildings, equipment or stock tend to be partial losses and not total losses and an insurance company needs to collect enough in premiums to cover all losses and expenses. It is impossible to know who is going to have a partial loss verses a total loss, so to stop businesses from only insuring a portion of the value of a given building, equipment or stock a “Co-Insurance” penalty is contained in the contract wording. In simple terms this clause states that insured losses are settled on the basis of:
The Amount of Insurance Purchased Divided by the Amount of Insurance that should have been Purchased, multiplied by the loss.
A very simple example would be a building that has a reconstruction value of $200,000 and $100,000 of insurance coverage was purchased. A loss of $50,000 occurs, settlement would be:
$100,000 divided by $200,000 multiplied by the loss $50,000 = $25,000 paid by the insurance company.
The only method available to determine the replacement value of your building is via a full appraisal of the property. Appraisals come in a number of formats;
(a) Real Estate Appraisal, which determines the selling value of your property, this type of appraisal has no bearing on the construction costs involved to replace the building.
(b) Full Evaluation Appraisal, this type of appraisal provides the costs involved at a given point of time to re-construct your property with similar materials. In accepting the amount provided by this type of appraisal you must also consider how the economy has been performing. Construction Costs and Labour Costs are always in a state of flux (usually upwards) and can rise upwards of 15% to 20% in a very short period of time. A major catastrophe where numerous buildings have been damaged can produce an instant 30% or more increase in costs due to supply and demand. Is my appraisal value plus a cushion of 30% sufficient? Not necessarily but it is safer than being substantially under insured.
Other factors which should be taken into consideration are various BY-LAWS which might exist in your community. Some By-Laws may require you if your property is damaged to more than a specific percentage of its total, to demolish the building and re-construct with different materials, or you may be required to demolish the building due to zoning and re-construct in some other part of town. This type of situation would inflate construction costs well past the value provided by the appraisal. As an Insurance Broker we are not equipped or trained to provide you with an appropriate amount of insurance on your building, but a good start is with a full appraisal by a qualified appraiser.
In today’s age equipment can be manufactured virtually anywhere in the world. The only person qualified to provide an adequate amount of insurance to replace the equipment would be yourself or your management. Metal costs fluctuate up and down based on supply and demand. Possibly the most appropriate method of determining replacement values is to have a list of all equipment and machinery, don’t forget electrical equipment and transformers (Copper prices have risen substantially) and telephone your suppliers at least once per year to ask about today’s cost to replace a specific item of machinery or equipment. Similar to that noted under Building, your policy will in most instances also have a Co-insurance Clause which applies to equipment. Often especially with large or specialized manufactures the equipment can be more difficult to replace than the building they are housed in.
Only you know the value of the stock you have on hand and your costs associated with replacing it. Consideration should be given to your long-term plans especially if you expect to have more stock on hand either at specific times of the year or because your business has more customers. To provide appropriate insurance coverage, your insurance broker requires this information.