The Risks of Underinsuring Your Commercial Real Estate Assets
A high inflationary environment and an uptick in natural catastrophe events have many risk professionals taking a second look at their property values. Since 2019, the actual cost to replace a commercial property after an event has increased by 39.85% year-over-year. As a result, premiums have been rising by double digits in many markets, with some insureds having to renew policies with half the coverage for the same total price.
The first quarter of 2023 was no different and, to some extent, even worse. The Council of Insurance Agents & Brokers reported that the average increase in commercial property premiums spiked to 20.4% — the first time since 2001 that this line recorded an increase higher than 20%. At the same time, carriers are focusing more on an account’s property valuation and loss history, to the point that some accounts with undervaluation were hit with surcharges, and those with higher loss frequency faced non-renewal.
Today’s risk environment means that businesses are facing more frequent property losses, and the costs of rebuilding are higher. Consequently, when a claim occurs, many property owners might find that they haven’t purchased an adequate insurance limit to cover the costs of rebuilding. Risk managers are responsible for working with their brokers to accurately report estimated replacement costs to their carriers. If they haven’t updated their values to account for inflation and increased property risks, they might find gaps when a claim occurs.
The risks of undervaluing commercial properties are many. Most property insurance policies contain coinsurance or margin penalty provision that requires the value of a claim based on the percentage insured and the amount underreported. If a loss occurs, property owners may have to finance the gap between the amount of insurance they purchased and the costs to rebuild. Senior leadership may come to doubt their risk teams, and carriers may impose penalties if gaps between replacement costs and reported property values persist.
Don’t Pay Out of Pocket If Catastrophe Strikes
One major reason risk managers want to ensure property values are accurately reported is so that they know they will have enough coverage in the event of a loss. If a hurricane damages a property and the value of the building is more than the limit purchased, a business will have to pay out-of-pocket.
No risk professional wants to face an insurance coverage gap. Companies may not have the additional funds needed to rebuild and return to normal operations in a timely manner. Even if they can afford to rebuild, it is frustrating for commercial property owners to take on additional costs when they thought they had enough insurance to protect them from claims.
Risk managers should regularly assess building replacement costs to ensure they have enough insurance in the event of a claim. Looking up replacement cost data imputed by adjusters and contractors can help risk professionals assess similar buildings and estimate how the inflationary environment has impacted their own costs over the past few years.
Risk professionals should also look for signs that a property’s value needs to be reassessed. If a company has made significant renovations or introduced new, smart, or green building technology to the space, it might be time to adjust its value. Properties located in booming real estate markets, high-risk areas, or those where construction costs have increased may also warrant a second look.
Maintain Trust of Senior Leadership
If a loss reveals a gap between insured value and replacement costs, risk teams will likely face increased scrutiny from their company’s senior leadership teams, including members of the C-Suite. Executives may question when the last time property values were adjusted and how risk managers have been monitoring the impact of inflation on rebuilding costs.
Premium surcharges and repeated losses with valuation issues will cause senior leadership team members to question how risk professionals are determining replacement costs. In the past, risk managers may have adjusted their insurance values by a given percentage each year and conducted more thorough assessments every few years. Those standard practices are no longer sufficient as inflation has rapidly increased the costs of rebuilding.
To maintain the trust of senior leadership, risk managers need to be able to articulate how they calculated their buildings’ replacement costs and what steps they’re taking to ensure the valuations are up-to-date and in line with inflation rates. Conducting regular assessments and accessing real-time replacement cost data can help risk managers assure the C-Suite that their property portfolios are adequately protected.
Avoid Coverage Gaps and Carrier Penalties
If a property faces frequent losses, carriers might impose penalties on insureds in an effort to protect themselves from claims. If risk managers don’t correct their commercial property insurance valuations, they need to be prepared to have coinsurance provisions and margin clauses imposed on their policies.
These penalties work in a number of different ways. With coinsurance, an insured pays a penalty if the policy limit they purchased isn’t equal to a pre-specified percentage of the property’s value. If a coinsurance clause says a property needs to be insured to at least 80% of its value and an insured only insures it to 60%, they will pay a fee upon loss.
A margin clause, on the other hand, works almost in the opposite way. Policies with margin clauses state that carriers will only pay for a certain amount over the reported value if a loss occurs.
Of course, insurers may also opt out of insuring property portfolios that have repeatedly seen losses with major valuation issues. That’s why it’s essential for risk professionals to make sure they’re correctly reporting their estimated replacement costs in the first place.
Be Prepared for Renewal
Risk managers and their brokers can go into renewals prepared if they are equipped with accurate replacement costs. Knowing how much it will take to rebuild can help insureds negotiate with carriers so that they can get accurate limits at an adequate price.
For instance, if a carrier wants to add a margin or coinsurance clause at renewal, a risk manager can leverage their updated replacements cost data to argue against the penalties.
Additionally, this data can help risk managers know that carriers aren’t taking advantage of them when it comes to policy limits and pricing.
LineSlip’s True Replacement Cost
LineSlip’s True Replacement Cost feature helps risk professionals feel confident that they’re accurately estimating their company’s commercial property replacement costs. The feature’s database allows risk managers to compare their coverage limits to determine a building’s insurable value in real-time, so they can assess how inflation might be impacting their value ahead of renewal. With this feature, companies are now armed to efficiently negotiate property renewal terms or claims with insurers.