Record inflation numbers, supply chain challenges and labor shortages are significantly impacting the commercial property industry. Owners are discovering their policies are undervalued and footing the bill for claim damages and potential coinsurance penalties. For this reason, policyholders should evaluate their coverage’s insurance-to-value (ITV) calculation.

An ITV calculation refers to an approximation of the full cost to replace or restore your insured property. Businesses can supply inaccurate ITV calculations by leveraging ineffective property valuation methods, intentionally underestimating costs to reduce premiums or other factors outside of their control (e.g., inflation). These inaccuracies are all too common, as an estimated 75% of commercial properties are underinsured by 40% or more.

What Is Insurance-to-Value? 

Accurate ITV calculations represent a closely equal ratio between the amount of insurance a business obtains and its estimated commercial property’s value. This ensures adequate protection following property losses.

It’s important to keep in mind that a property may be assigned several different values, including:

• Market value is an estimate of a property’s selling price in the present real estate market. A property’s market value is determined from elements such as lot size, building condition and location desirability.
• Assessed value is an approximation generated by the property’s municipality and is typically utilized to determine local property taxes.
• Replacement value is an evaluation of the current cost to replace or rebuild a property and is dependent on characteristics such as material and labor expenses, architect services, debris removal needs and building permit requirements.

Insurance experts recommend using the replacement value 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 are 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’re deemed the most thorough and accurate.

Factors Impacting Property Value

Businesses should also consider the following factors to determine correct property valuations.

Direct & Indirect Expenses

In addition to direct costs, such as material and labor expenses, property valuations should incorporate indirect costs, such as consulting fees, engineering services and other expenses not directly associated with rebuilding.

Property Age

In the case of older structures, property valuations should include additional construction costs that may arise from upgrading outdated building materials and equipment.

Building Codes

Older properties may also require certain modifications amid the rebuilding process to comply with modern building codes (e.g., plumbing improvements, energy efficiency upgrades, sprinkler system changes, safety enhancements). These adjustments may further compound construction costs, driving up property valuations.

Property Accessibility

Properties situated at steep locations or adjacent to neighboring structures may need to have bracing or other safety measures put in place during demolition and rebuilding operations to ensure accessibility.

Unique Features

Some custom property elements (e.g., stained glass) require specialized construction work, which elevates rebuilding costs.

Consequences of Property Undervaluation

Businesses could face several ramifications if they conduct inaccurate ITV calculations and undervalue properties. Namely, businesses may lack sufficient coverage following property losses, forcing them to pay out-of-pocket expenses to fully rebuild. Depending on the severity of the property loss and associated rebuilding operations, paying these costs out of pocket could lead to major financial setbacks and bankruptcy.

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 (e.g., a reduced payout) if their coverage limit is not at least equal to a predetermined percentage of the property’s value.

Coinsurance penalties limit the amount a business can recover following a loss. A policyholder who doesn’t meet their coinsurance clause requirements will see their claim’s amount adjusted. For example, consider a $1 million-valued property with a $700,000 coverage limit and an 80% coinsurance clause. The insured would only receive a $43,750 payout for $50,000 in property damage from a covered event: ($700,000/$800,000) x $50,000 = $43,750.

Tips to Improve Your Property Valuations

Here are some additional best practices to help ensure accurate ITV calculations and improve property valuation measures:

Locate a Reputable Appraiser

Insurers consider third-party appraisals the gold standard in property valuations as they reassure calculations are conducted by experienced and objective professionals. As such, it’s vital to secure a trusted and reputable appraiser. Find a firm that follows the Uniform Standards of Professional Appraisal Practice and the Code of Professional Ethics and Standards of Professional Practice from the Appraisal Institute.

Pursue Supplementary Resources

There are additional industry resources, reference guides and validated tools available to help ensure accurate property valuations. Specifically, the Marshall & Swift Valuation Service Cost Manual is widely accepted by insurers. This resource features more than 30,000 component costs across 300 building occupancies that can be referenced when conducting valuations.

Consult Other Parties

Determining the value of a property should be a team effort. Make sure to compile a variety of property data from multiple qualified parties (e.g., accountants, contractors, real estate experts, risk managers, insurance professionals, chief financial officers) when making valuation decisions.

Make Updates as Needed

The value of a property is always changing; this means it’s imperative to update property valuations regularly. The frequency will depend on factors such as changing property exposures, altering operations, building upgrades or modifications, implementing innovative technology or equipment onsite, shifting market conditions, and property construction trends (e.g., inflated labor, material costs). Work closely with your trusted insurance professionals when updating property valuations to maintain ample coverage and prevent coinsurance penalties.

We’re Here to Help You Properly Insure Your Commercial Property

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. If you have questions about your property’s valuation or commercial property insurance, connect with a member of our team.