Coverage Corner

BUILDING REPLACEMENT COSTS – HOW TO PROTECT YOURSELF AND YOUR COMMERCIAL CLIENT

By Cathy Trischan, CPCU, CRM, CIC, ARM, AU, AAI, CRIS, MLIS, TRIP

Most agents have had the same conversation numerous times. Your insurer feels the building replacement cost supplied by the client is too low. Your client insists the insurer’s number is too high. “I can’t sell the building for that! I can rebuild this building for $150 a square foot!” Clearly, some client education is needed.

According to Verisk’s 360Value Quarterly Reconstruction Cost Analysis, total reconstruction costs increased an average of 9.3% from October 2021 to October 2022. Labor and material shortages and inflation continue to have an effect on property replacement costs.

Most property owners do not know the true cost to rebuild their property. Agents, wanting to help, often prepare a replacement cost estimate. There are a few problems with this, for both the client and the agent. First, most agents do not have access to a full replacement cost estimating program. They use the insurance to value calculator in an insurer rating program to come up with a rough number based on location, construction type, square footage, etc. Even if the agency does have access to an estimating program, it is unlikely that it has all of the information about the building needed to come up with an accurate number. Does the agent know details about the basement, roof covering, HVAC system, and numerous other building components? The tools are excellent, but remember the old adage – garbage in, garbage out.

It is the insured’s responsibility to provide a limit of insurance. The agency who tries to help and provides incorrect information creates a problem for the insured and for itself – that problem is E&O. If an agency helps an insured calculate a limit, the agency should include a disclaimer making the insured aware that the number is just an estimate based on limited information. The agency should recommend that the client obtain a professional appraisal, even if the agent believes the client will not do so. Not only will such a disclaimer emphasize the importance of professional advice, it can aid in the defense of an E&O claim should one be made. (IA&B has a Disclosure for Replacement Cost Estimators available for use by member agents: IABforME.online/EO-prevention)

Other than the agent’s educating the insured about the importance of getting an accurate replacement cost, what else can be done to protect the client?

If the insurer agrees that the limit chosen is correct, it may agree to add the optional coverage of agreed value. While it is still possible that the limit chosen will be too low, the possibility of a coinsurance penalty is eliminated because agreed value suspends coinsurance. Some insurers offer endorsements that provide the same type of protection on a Businessowners Policy (BOP). The ISO endorsement BP 04 83 01 10 Removal of Insurance-to-Value Provision is an example.

Blanket limits covering building and personal property and/or property at numerous locations can reduce the possibility of an inadequate limit. If the insured has two buildings included in a blanket limit, for example, the full blanket limit is available should only one building be damaged. Adding agreed value ensures that there will not be a coinsurance penalty.

Inflation guard is an optional coverage on a property policy that increases the limit by a small amount each day. As an example, if a 10% inflation guard is added, there would be an additional 10% of the limit available for a loss on the last day of the policy period. If the loss happens halfway through the policy term, an additional 5% of the limit is available.

Higher replacement costs are sometimes the result of increased demand after a disaster. Adding an endorsement such as CP 04 09 10 12 Increase in Rebuilding Expenses Following Disaster can provide an additional percentage of the building limit to the insured if the building limit is inadequate due to the price increases that accompany a demand surge.

Lastly, some insurers have endorsements that provide an additional amount of coverage should the insured find that, at time of loss, the limit selected is too low. The insurer will charge a premium for the extra coverage when the claim is paid, a bill most insureds will gladly pay in exchange for the extra dollars of coverage.

Coming up with a proper replacement value for a building is important and is, ultimately, the insured’s responsibility. An agent who wants to help should be cautious in doing so. And regardless of who comes up with the limit, coverage options to help reduce the effect of an inadequate limit should be explored. These steps help the agency and the client.

Til next time!

Cathy Trischan, CPCU, CRM, CIC, ARM, AU, AAI, CRIS, MLIS, TRIP is IA&B’s commercial lines education consultant. She works with our CIC and CISR programs, as well as our live CE webinars. Catch her at one of our upcoming courses: IABforME.com/education

An audio version of this article is also available as a podcast