3 Risks of Having the Wrong Commercial Property Coverage
June 11, 2020Commercial insurance can feel like a rather complex financial risk management tool and many insureds simply file their new policy paperwork each year without so much as a second thought. The policy language and general subject matter of insurance can be confusing in many circumstances. That’s why it is a good idea to conduct an annual review of your insurance coverages with your agent. There are many risks of having the wrong commercial property coverage and an annual review can help uncover and resolve those before they cause you issues.
However, the value of those reviews is only as good as your agent’s knowledge and expertise about the product that they are selling. So, the second benefit of an annual review is that it will help you to decipher the level of customer service value you are obtaining out of your partnership with your insurance agency of choice.
During an annual review, your insurance agent will help you assess and manage probable and possible risks to your type of business, and the assets held by it. This is a consultative approach to writing insurance, and it is an important part of the underwriting process. During these conversations, you and your agent can uncover potential coverage gaps that can occur when your business evolves and surpasses what your current policy provides.
Uninsured claims can arise from new and different exposures that have presented themselves since the policy’s initial inception. There are several ways that having the wrong, or inadequate, commercial property coverage can present increased financial risks to your business. If you think that any of them pertain to your business, it is a good idea to schedule an insurance review with a knowledgeable agent and either gain some peace of mind or mitigate any gaps you uncover with additional coverage.
Here are a few major risks of having the wrong commercial property coverage:
1. Co-Insurance Penalties
One of the most common policy issues that presents itself on Commercial Property policies is that buildings and other business property are not insured to value. When a Replacement Cost provision is included on the policy, the property must be insured to at least 80% of the cost to replace it with “like kind and quality” in order to receive Replacement Cost for repairs to buildings or equipment damaged in a claim.
What is Replacement Cost?
The easiest way to think about Replacement Cost is that the insurance company is giving you “new for old”. To justify the cost of fulfilling their contractual obligations to their policyholders and replace an old building with a new one, the insurance company needs to rate the cost of the insurance for the building based on the cost to replace it, not based on its actual cash value (which accounts for depreciation of the property).
How Does a Co-Insurance Penalty Occur?
In times of soft real estate markets, it is very common for business owners to be able to acquire real property assets for far less than the cost to build. Ultimately, this creates confusion when the property owner seeks to obtain insurance coverage because the financial investment that they have put into the property is often lower than the limit of insurance on their policy.
In order to save money on their insurance policy, many insureds look to reduce the value of buildings that are listed on their declarations page. But, if Replacement Cost is on the policy, buildings need to be insured to 80% of the cost of replacement. If this requirement is not met, a co-insurance penalty will be assessed if a loss occurs.
How is a Co-Insurance Penalty Assessed?
The factor used to complete the penalty calculation and determine how much of the loss the insurance company will pay is as follows: the amount the building was insured for, divided by the amount the building should have been insured for, multiplied by the amount of the loss, minus the policy deductible.
So, for example, assume a building should be insured for $100,000, but the insured chooses to insure it for $70,000 with a $500 deductible. $70,000 is 70% of $100,000, so the 80% co-insurance requirement has not been met. Say our hypothetical building suffers a $5,000 roof damage claim.
Co-Insurance Penalty and Policy Deductible
Since the building was under-insured, the insurance company will use the calculation (70,000/100,000) X $5000 – $500. In this scenario, the insurance company will pay the insured $3,000 for the roof damage and the insured will be responsible for the additional $2,000 which is the amount of the co-insurance penalty and the policy deductible.
Straight Depreciated Value
The insurance company may also pay the loss based on the straight depreciated value. So, in this example, a $5000 roof claim on a 30-year-old shingle roof could be deemed 50% depreciated and your payment would be $2000 after the deductible is applied.
Make Sure You “Insure to Value” When Replacement Cost is on the Policy
At claim time, the cost of underinsuring far exceeds the few dollars that were saved by reducing the insured limit of the building below the required 80%. For this reason, when a Replacement Cost provision is on a policy, it is always advisable to “insure to value”, as it is called in insurance lingo.
2. Uninsured Claims to Mobile Equipment
Business Personal Property (BPP) coverage and Inland Marine (IM) sometimes get confusing for insureds. At first glance, they can appear to be similar, since some kinds of equipment could be insured on either type of policy. But, getting it wrong can create coverage gaps. And, some equipment can be difficult to place on a policy. Insuring a drone for business use, for example, can be difficult and requires the right kind of property coverage.
Business Personal Property Coverage
Items that stay on-premises can be insured with BPP if they remain within a very limited radius of an insured building. Unendorsed policies limit this to 100 feet, but many insurance companies automatically extend this radius to 1000 feet in their policy language. A forklift that operates in a warehouse and never leaves the premises can typically receive adequate coverage on the BPP coverage of a commercial policy.
Inland Marine Coverage
If that same forklift were loaded on a truck to unload supplies at a job site, damages to the forklift that occur off-premises will no longer be covered by BPP. In this scenario, an Inland Marine policy is a necessity. Inland Marine coverage is usually broader than BPP in terms of the causes of loss that are covered, and in terms of where it covers the listed property items.
Inland Marine will cover tools and equipment off-premises, on job sites, in vehicles, etc. So, when equipment is used off-premises or is mobile in nature, it becomes important to understand when an Inland Marine policy is needed to fill otherwise perilous gaps in property coverage.
3. Loss of Business Income
Coverage for Property Damage
When you consider your possible or probable property loss exposures, it is easy to look at a building that costs several hundred thousand or even several million dollars and understand the need to insure that property asset for losses like fire, windstorm damage, collapse due to ice and snow, etc.
For many businesses, the loss of a key building would make it difficult to operate, so the need to ensure the ability to rebuild without acquiring an onerous debt load is quite evident. If the purchase or construction of buildings has been financed by a financial institution, property coverage becomes mandatory.
However, given that the replacement of the building is imperative to the continuation of business operations, it is also worth noting that other financial losses of even greater magnitude can occur during the time the building is uninhabitable or being reconstructed.
Coverage if Your Business is Temporarily Un-Operational
Loss of Business Income Coverage
If the loss of a building would make your business un-operational for a period of time, as would be in the case of civil unrest, damage from a storm, etc., you have an inherent Loss of Business Income exposure that you need to consider. Loss of Business Income coverage can be triggered when a covered cause of loss occurs to an insured property that temporarily affects the business’s ability to operate at full capacity.
There are several options within this coverage that can be added, such as payroll expense or “key man” coverage, which allow you to obtain a claim payment to continue to pay your employees during the business’s downtime. Or, you can select key personnel that you need to ensure you keep on staff so that, once you are up and running again, your business can return to operations with those vital team members.
Extra Expense Coverage
Extra Expense coverage can also be added and is an important coverage if your business would incur more expenses to remain operational following a property loss. Without this coverage, the financial losses associated with damages to a structure can pale in comparison to income losses realized following the loss or the difficulties experienced in re-staffing your business if your key employees were forced to find other employment while the business was rebuilding.
These are just a few of the risks of having the wrong commercial property coverage. When it comes to commercial insurance, package policies become a customized and tailored risk management product that is unique and different for each policyholder. One business’s needs are not the same as another, and so each business owner has the ability to choose what types of risks they want to transfer to the insurance company via contractual agreement and which they are comfortable in self-insuring.
Simply buying “a” policy does not ensure that any, and all, loss exposures are covered. It is important to have a detailed conversation about these often-overlooked aspects of commercial insurance with an experienced independent agent to make sure that risks to your business are properly accounted for on your insurance policy and you do not end up with the wrong commercial property coverage.
If you would like to review your current coverage or obtain a quote for new coverage, give us a call at 1-800-537-6880 or 717-665-2283 and one of our customer service representatives can help you acquire the coverages that are applicable to your business operations.
Disclaimer: Information and claims presented in this content are meant for informative, illustrative purposes and should not be considered legally binding.