California wildfires in 2017 destroyed more than 10,000 structures. In 2018 that number doubled to more than 22,000, and the outlook in future years is unlikely to improve. Couple that with the more than 693 confirmed tornadoes in the United States during the first five months of 2019, and we get a clear picture of the devastation that fire and tornadoes leave in their wake. And, let’s not forget the horrible floods this spring. For those individuals who lost their homes and businesses because of these natural disasters. the process of rebuilding is going to be frustrating because reconstruction costs have increased in the last couple of years. A commercial building damaged in a fire or tornado may cost a lot more to replace than when it was originally built. Changes in the building codes may require more energy-efficient materials or they may require added safety features. all of which will increase reconstruction costs. Building materials such as lumber and steel are more expensive. Licensed and bonded contractors may or may not be available and labor shortages in the qualified trades, such as electricians and plumbers, may delay completion time, which adds to the cost.
“Marketers need to have an accurate understanding of reconstruction costs, and how these are factored into their property coverage,” according to Guy Kopperud, industry solutions principal for CoreLogic’s Insurance and Spatial Solutions, in an article published in the May edition of Business Insurance.
The truth of the above statement is something we have discussed with marketers for many years. It’s extremely important to know what reconstruction costs are for your fixed assets in your local area so that you have enough insurance to rebuild in the event of a covered loss. Here is where we remind marketers that flood, earthquake, or earth movement is not covered under the vast majority of package policies and the coverage must be purchased separately.
When buying property insurance, coverage is usually written either on a replacement cost basis (new for old) or they are written on actual cash value (new less depreciation). If replacement cost (RC) or actual cost value (ACV) is offered, the policy nonnally carries a coinsurance clause requiring the marketer to insure the structures to 80%, 90%, or 100% of the cost to rebuild.
Replacement cost is determined by getting several bids from qualified contractors to rebuild all or just the part damaged. The average amount that the contractors quote to rebuild or replace the structure is the starting point. The next step is finding out if your current property insurance meets the required co-insurance clause on your policy. For example, the contractor’s bid that was accepted to replace your building is $110,000 and you had the building insured for $100,000 (110,000 x 90% co-insurance”‘ $99,000). You meet the co-insurance requirement. No penalty is involved and, minus your deductible, you can expect to receive the full amount shown on your policy when or if you rebuild. In addition, the policy may have some provisions to provide extra money if you are required by statute to upgrade.
In the above example, meeting the coinsurance requirement does not make the propane marketer whole. It leaves $10,000 still needed plus the $1000 deductible because the insurance company will not pay more than the $100,000 shown on the policy. The solution in this example is to know reconstruction costs in your area and insure to that value.
Next let’s look at insuring the building at actual cash valuation (ACV) with the same co-insurance requirement. We start with getting the quotes from several builders, the same as under replacement cost (RC). The contractors agree that to replace the building is going to cost $110,000 and the insurance coverage is $100,000. The claims adjuster is then going to look at the construction of the building, the age of the building, occupancy, condition, and location and determine how much depreciation should apply. The adjuster in this example determined that the depreciation on the building is 35% or $38,500. The building was insured for $100,000, so the co-insurance penalty won’t apply. The market: ers would get $100,000, minus the depreciation of $38,500 minus the $1000 deductible. They would get $60,500, leaving him $49,500 short of being able to rebuild. Now who’s in trouble? This is the area that causes more lawsuits for agents-failure to understand co-insurance and the need to properly value the property they insure. Why not buy replacement cost? Usually, when RC is not offered it is because the application submitted to the underwriter did not include any updates or improvements on the older buildings. Has the roof been upgraded or replaced? What about the electrical panel? These are samples of some upgrades that would allow the underwriter to change the ACV to RC. To further compound the marketer’s problems in the event of a fire or windstorm, the insured loss will bring other costs that are not easily foreseen. The property portion of your insurance policy has a sublimit to pay for cleaning up and disposing of the debris from a covered loss. However, to get back into business also brings unexpected expenses. If the loss was to a marketer’s main office, they must immediately decide how and where to get back in business. If their computer system is backed up either on a cloud or on a thumb drive, all that’s required is buying a new computer and downloading the information. But what about where? Are there vacant buildings available to rent temporarily until your building is rebuilt? And how much will it cost per month to rent? This is why having business income and extra expense coverage is so important. In August of 2006, I received a call from a fuel distributor that I insured. His office/ warehouse was on fire, and by the time I was able to get there, the building was a total loss. We had just renewed his insurance program and had doubled his business income and extra expense coverage. The rebuild was a nightmare, the city would not allow any lubricant storage, the office had to be sprinklered, and there wasn’t any office space available within close proximity. The permitting and rebuilding took a whole year. The insured used up the entire business income and extra expense limit on his policy just when the building was finished. Having that coverage, with an adequate limit, kept them in business.
Four lessons to learn from this article:
- Now is the time to look at construction costs to rebuild your structures in the event of a loss.
- Check your insurance policy. Do you have a coinsurance clause in your policy? Does the limit you are insured for meet the percentage requirements so that you will have sufficient funds to rebuild?
- Are you insured for replacement cost? If not, why?
- Make sure your policy has business income and extra expense.
If you are not sure, check with your insurance agent.
Frank 8. Thompson is a chartered property and casualty underwriter based
in Phoenix. He is the owner of PT Risk Management, an independent insurance company specializing in writing propane and petroleum risk policies throughout the U.S.