An avoidable insurance mistake that many businesses make is under-insuring their buildings. When completing the application, they are required to give a value for the building. Often, the only reference points the owner have is the real estate value or loan amount. They do not realize that under the terms of the property policy; it pays for the cost to repair or reconstruct the building, not the market value.
Some types of buildings, particularly older structures, have reconstruction costs which far excess the real estate value. Also, in older cities or depressed areas, the disparity can be quite high. In the event of a total loss, a payment of the real estate value may be sufficient. However over 99% of all losses are partial losses requiring restoration and repair. In this case, underinsurance can be a serious problem for the insured. The insurance claim may be insufficient to pay for repairs, or the policy may penalize the owner for underinsuring the property.
The property should be valued based on the reconstruction cost. Reconstruction cost is based on factors such as the type of building, size, design, materials and the local cost of labor.
The responsibility for determining the property value lies with the insured. A building owner should have the Property valued based on reconstruction cost. There are property appraisal firms that do this. Larger insurance agencies may have qualified loss control consultants who can examine a building and generate a replacement cost estimate using Marshall & Swift or other software. Either of these approaches can assist the property owner in avoiding the ‘real estate value trap.’
If you are a commercial building owner, I hope that this prompts you to have a conversation with your insurance professional regarding your building limits.