When businesses need to cut costs, it’s tempting to reduce insurance coverages, especially for property – building and contents. Here’s why cutting corners on property insurance is risky business.
Commercial real estate prices have declined 39 percent over the past two years, as tracked by the MIT Commercial Property Price Index. If you own business property and its market value has declined, you may think you have an opportunity to save money by decreasing your property insurance limits to match the property’s lower market value.
Not so fast.
Sometimes business owners confuse market value with replacement cost. Replacement cost is the amount of money it would take to replace your building in the event of a total loss.
“Market value is driven by market conditions, supply and demand, emotion and fear,” according to Peter Wells, president of MSB, a leading supplier of building-cost data. On the other hand, “the cost to rebuild is based on hard facts such as wages, materials, equipment and labor.”
In order to be fully insured – to have insurance-to-value – you need limits equal to the full cost of replacing the property, regardless of its current market value.
Construction Costs Increase
Construction costs have not declined, even as the real estate market has nose-dived. According to Wells, construction costs continue to inch up, increasing three percent nationally in the last year. The costs of petroleum-based materials such as pipes and shingles have increased, though labor costs have declined and hungry contractors sometimes cut their profit margins to get work.
Other factors leading to higher costs include:
- Increased insurance costs for contractors
- Increased taxes on construction in some localities
The bottom line: Construction costs are up.
Reconstruction Costs More
Another reason to maintain solid replacement cost limits is that rebuilding often costs more than building a totally new structure. There are several factors that make replacement costs higher:
- Demolition and debris removal
- Difficulties in accessing the property
- Building code upgrades
- Extra expenses to match existing materials
- Protection for undamaged property
Additionally, if your building is damaged in a major disaster, construction costs will be significantly higher due to higher demand and decreased supply of labor and materials. After Hurricane Katrina, material costs increased not just on the Gulf Coast, but all across the country.
Contents Valuation
Whether you lease or own your workplace, it is important to make sure your contents are insured to value. MSB tracking data for a 10-year period show that the majority of businesses have contents that are more than 50 percent undervalued.
If you would like to discuss property limits for your contents, give us a call, and we will reassess your coverage needs.
Business Interruption
According to the Institute for Business and Home Safety, 25 percent of businesses that close following a disaster never reopen. Often, a major reason is that the businesses did not buy enough business interruption insurance, also known as business income insurance.
As with property insurance-to-value, it is important to accurately estimate how much business interruption insurance you need. It has always been difficult to precisely calculate worst-case scenarios. Give us a call if you would like to talk about business interruption.
Saving Money in a Weak Market
There is a silver lining in the weak real estate market. If you lease your business space, it may be possible renegotiate the lease. According to the National Association of Realtors, office vacancies will peak at almost 19 percent in 2010. Industrial vacancies will exceed 11 percent. By the end of 2010, industry experts believe the real estate market will begin to recover.
In the long run, lower rent plus solid insurance coverages will help your company manage both expenses and risk.