RISK EDUCATION – Just because you’re paying premiums on Commercial Property Insurance doesn’t mean your company is adequately covered for loss.
Without setting the correct limits on your policies, you won’t receive the funds you need to completely rebuild. And even on partial loss claims, you’re probably going to lose a significant amount to Co-insurance Penalties.
This might be alarming to hear, but you’re not alone.
“A vast majority, 75-80%, of our new clients in the last 40 years have been underinsured.” —Walter Haney Sr.
But, unless you’re the Owner or CEO of a construction business, there’s a good chance you just don’t have the knowledge or experience needed to set realistic rebuilding limits.
We’re happy to offer you some suggestions on setting limits from a Risk Management perspective. But we’re also going to remind you of the need to personally consult with an Independent Risk Manager.
Your Insurance Agent’s duty is to fulfill your order based on limits provided by you. A Risk Manager will look out for your best interests—making sure correct limits are set. Plus, they can usually find increased and enhanced client coverages, AND premium savings, as well.
Key Considerations On Setting Property Limits
The process of setting limits for your company’s Property Insurance Coverage starts with establishing the needs of YOUR specific business.
If you have a brand new facility, with all new equipment, then your needs will be much different than a company that’s running its entire operation out of a portion of an old manufacturing building.
What about the size of your facility? Do you own multiple buildings? In how many different locations? What are the structures of your buildings? Are they constructed out of brick? Metal? Concrete?
What kinds of equipment, interior furnishing, inventory, and other contents will you need to replace if they’re lost or damaged?
After you establish your needs, THEN you determine the value.
Values are not something to be estimated on paper from a faraway office.
A Risk Manager will visit all the properties of their clients. They’ll walk around. They’ll take a good look at their client’s operations inside and outside. They’ll visit the manufacturing floors and observe the work in process.
For example, if you’ve been running your business for decades, you might have replaced older machinery with new technology—needing less room than before. (You won’t NEED to build back to the same size.)
Technology changes could also mean you’re using automated machinery and may have downsized the number of employees over the years. (You won’t NEED to rebuild a facility for 1,200 employees, if you only have 500.)
A Risk Manager is also going to check the prices for replacement machinery. (Do you NEED new machinery or will second-hand work just as well? Does this machinery NEED to be shipped from overseas?)
A Risk Manager will also check the construction cost by square footage based on local labor in your area. (In your city, does labor average $100 a square foot? Or are you in an area with costs around $300 a square foot?)
Another important consideration deals with insuring machinery that doesn’t stay in a fixed location, but moves around, being used in different places. Known as Contractors Equipment or Inland Marine, this type of business property also needs to be insured, with detailed lists kept and replacement limits set.
For example, a Utility Company that provides gas, power and water to its customers could use the same Inland Marine Equipment (such as backhoes, welders, trenches and cranes) in all its different departments and locations.
You’re also going to have to provide lists (called Schedules in the Insurance World) of all your computers, telephones and digitally-controlled equipment and machinery.
Costs for office contents are easily underestimated. And check to make sure you’re not still paying premiums based on new equipment 15 years later. Older equipment will be depreciated at claim time.
Again, these are just samples of numerous considerations. Hopefully, you realize by now that you and your business deserve a professional opinion.
A Risk Manager is going to make sure you’re covered. They’ll follow a detailed process that includes looking at all of your current insurance policies, closely examining all limits and values, and then comparing them to your specific needs.
They’re also going to double-check that you’re covered under the correct Property Coverage Value type, which brings us to our next topic.
Property Insurance Value Breakdowns
There are different types of Property Insurance Coverages and the one that’s best for your company is the one that best fits (you guessed it) YOUR NEEDS!
Types of Property Insurance Coverage can include:
- Replacement Value;
- Actual Cash Value; and
- Functional Replacement.
If your company is new or you’re still manufacturing the same type of items, using the same equipment and using the same sized spaces in your facility, you’re probably going to want to insure at Replacement Value, also known as Replacement Cost.
Insuring to the proper Replacement Value means you’ll be able to replace your facility and equipment—everything that is damaged or destroyed—with the correct amount of money needed to replace both its size and quality level.
Actual Cash Value
Whatever a willing buyer would pay for your facility; its structure and its products TODAY—is called Market Value, also known as Actual Cash Value. But insuring with this type of policy means that depreciation will be deducted from your insured amount.
Rebuilding a structure usually costs considerably more than its previous value because of debris cleanup and site prep, as well as increased costs for raw materials and local labor.
(Side Note: Land, driveways, parking lots, slab and foundations are not usually included in any type of policy, unless specifically requested.)
If you have an older facility and maybe only use a portion of it, or your equipment has changed with technology and you don’t need as much space, you might consider insuring for Functional Replacement, also known as Agreed Value Provision.
With this type of coverage, you’ll be focusing on needed values more than present values. You’ll be moving toward what you’d actually need to build back, if you have a claim. And you won’t take a big depreciation hit or be subjected to a Co-insurance Penalty.
Plus, there are only minimum requirements that you’ll have to meet to fulfill your end of a Functional Replacement Contract AND you and your insurance company can come to this understanding before any losses occur.
“That’s what a Risk Manager is supposed to do—settle the claim—before the claim happens.” —Walter “Wally” Haney Jr.
If you have an endorsement from your insurance company that you’re only insuring to Functional Replacement or an Agreed Value Provision, then you don’t have to worry about Co-insurance Penalties.
But if you are insuring your property to Replacement Value or Actual Cash Value, then both of these types of coverages will have Co-insurance Clauses built into the policies.
What does this mean? This means that you must set proper limits for these coverages. You can’t insure a $3 million building for only $1 million. You’ll pay a steep penalty for being under-insured. You’ll actually be considered as a “Co-insurer,” thus the Co-insurance Penalty.
Penalties are set on a percentage basis, usually 80%. But some companies could use different percentages, such as 90%.
In this case, the amount of insurance you purchased (say $1 million) would be divided by the amount you should have purchased (the $3 million) and any losses—big or small—will be reduced by this same amount.
For example, even if you only had $100,000 worth of smoke damage to your $3 million facility, since you had lower limits than you should have had, that $100,000 will be divided by 3—the same percentage as $1 million divided by $3 million (.333). You’ll get $33,333 back (less your deductible) on this $100,000 claim.
Added Protection: Business Income Insurance
A Risk Manager will not only help you establish the correct amount of Property Insurance Coverage, limits and values you need to get your business back up after a disaster, they’ll also suggest added protection.
You can have a provision included in your policy to provide extra financial help (including payroll expenses) until your business is operating to the level it was before the incident.
Known as Business Income Insurance or Business Interruption Insurance, this crucial coverage is always recommended to our clients. More information on these policies and their benefits can be found in Business Income Insurance: Protecting The Lifeblood Of Your Company.
Saving On Premiums By Using Deductibles
Okay, so you’ve learned about setting proper limits and you’ve added Business Income Insurance. Are you interested in saving money on the front-end—the premiums you pay?
A Risk Manager can take a look at your losses to see if your company would be a good fit for Self-insurance Coverage. In this case, you would be assuming responsibility for part of (or whole) building losses. The amount of loss you choose to accept is called a “deductible.”
“We’ve done this for most of our big accounts. We were able to save them a lot of money by putting in correct deductibles. And we’ve been thanked for finding such significant savings—being told our help was ‘Spot On.'” —Walter Haney Sr.
Loss Premium Models
Your Risk Manager can use Loss Runs established over the last 7 years and calculate limits that can significantly lower your premiums.
These types of equations are known as Loss Premium Models and they follow a step-by-step process.
Risk Managers will:
- Begin with your values;
- Overlay your past loss history;
- Calculate correct limits;
- Factor in different deductible amounts; and
- Determine how much you would cost yourself if you covered your losses using these various deductible amounts.
Higher deductibles can create lower premiums, as you are taking on more Self-insurance responsibility. And if you have no losses, that’s even more money you can put back into your pocket (and your business).
“You estimate possible losses over 7 years (based on your history) to see what the cost would be. It might be zero. You may not have any losses in there—particularly with property. With property, you don’t have any losses or you have big losses. You don’t have any nickel and dime stuff.” —Walter Haney Sr.
For some clients, larger deductibles can greatly reduce premiums. One company may be able to handle a $100,000 loss and easily write it off. A $10 million loss would be hard for any company to survive.
Last, but definitely not least important, is Blanket Coverage.
You can get Blanket Coverage and Blanket Limits so that you can insure multiple locations and different types of polices.
You establish a specific Blanket Limit, but the entire coverage amount can also be used to fulfill a claim at one location, two locations—or all locations—up to that Blanket Limit.
You can also buy Blanket Limits for Equipment, Third-party On-site Contractor Equipment and (our good friend) Business Interruption Insurance, as well as for any other risk exposures you may have.
“You never know where a claim will occur, how long your business will be down, or how many people will be involved. Blanket Limits cover everything UP to the limit that you bought—it doesn’t matter where the incident occurs.” —Walter Haney Sr.
We hope you’ve found this post helpful and now realize the importance of prioritizing this issue to help protect your company. And we also hope you never have a reason to test the limits of your policies.