The Importance of Insurance to Value for Commercial Property Coverage
When purchasing or renewing their commercial property insurance, it’s vital for businesses to ensure such coverage includes correct property valuations. Doing so can make all the difference in providing sufficient protection and preventing coinsurance penalties amid covered property losses. That’s where conducting accurate insurance-to-value (ITV) calculations comes into play. Generally speaking, ITV refers to an approximation of the full cost to replace or restore insured property.
Businesses may end up with inaccurate ITV calculations for a wide range of reasons—whether it stems from leveraging ineffective property valuation methods, intentionally underestimating costs in efforts to secure reduced premiums or being impacted by factors outside of their control (e.g., inflation). Regardless, such inaccuracies are all too common. In fact, an estimated 75% of commercial properties are underinsured by 40% or more, according to industry data.
With these findings in mind, it’s evident that businesses need to take commercial property valuations seriously. This article offers more details on ITV, outlines factors to consider when determining a property’s value, explains the pitfalls of property undervaluation and provides best practices for improving property valuation measures.
An accurate ITV calculation represents as close to an equal ratio as possible between the amount of insurance a business obtains and the estimated value of its commercial property—thus ensuring adequate protection following property losses. However, it’s important to keep in mind that a property may be assigned several different values, including the following:
Generally, insurance experts recommend using the replacement value of a property to conduct correct ITV calculations. Common approaches to accurately estimating this value include getting a property appraisal from a third-party firm, leveraging fixed-asset records that have been adjusted for inflation or relying on a basic benchmarking tool (e.g., dollars per square foot). While appraisals often require more time and resources than other property valuation methods, they are largely deemed the most thorough and accurate.
Factors Impacting Property Value
Apart from utilizing replacement value estimates within ITV calculations, businesses should consider the following factors to determine correct property valuations:
Consequences of Property Undervaluation
Businesses could face a number of ramifications if they conduct inaccurate ITV calculations and undervalue their properties. Namely, businesses may lack sufficient coverage following property losses, forcing them to pay out-of-pocket expenses in order to fully rebuild. Depending on the severity of property losses and associated rebuilding operations, paying these costs out of pocket could lead to major financial setbacks and—in certain scenarios—bankruptcy.
Additionally, property undervaluation can sometimes result in coinsurance penalties. Most commercial property insurance policies include coinsurance clauses, which encourage policyholders to carry reasonable and accurate amounts of coverage. Under a coinsurance clause, a policyholder is subject to a penalty—generally, a reduced payout—if their coverage limit is not at least equal to a predetermined percentage (e.g., 80%) of the value of their property.
A coinsurance penalty limits the amount recoverable following a loss. To calculate the amount recoverable for a policyholder who doesn’t meet their coinsurance clause requirements, the amount of insurance carried should be divided by the amount of insurance required, then multiplied by the loss cost. For example, if an insured’s property is valued at $1 million, but their coverage limit is $700,000 and their policy includes an 80% coinsurance clause, they would likely only receive a $43,750 payout after incurring $50,000 in property damage from a covered event, depending on when their deductible is applied ((700,000/800,000) x 50,000 = 43,750).
Ways to Improve Property Valuations
Here are some additional best practices businesses can review to help ensure accurate ITV calculations and improve their property valuation measures:
Ultimately, it’s clear that correct property valuations are critical in securing adequate commercial property insurance. By better understanding how to conduct accurate ITV calculations, businesses can stay protected when covered events occur and avoid potential coinsurance penalties. Contact us today for additional insurance guidance and solutions.
This Coverage Insights is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice. © 2022 Zywave, Inc. All rights reserved.