Commercial Property Insurance & Rising Inflation
Today I’m going to talk about the impact that inflation is having on commercial property insurance costs. As well as how you should be preparing for your business insurance renewals.
Okay, so it’s July 2022 and we’ve seen the cost of building materials, as well as overall construction costs, jump pretty significantly for the past couple of years due to the pandemic, as well as supply chain disruptions, and increasing demand for construction and renovations across the board.
How does this affect your business insurance?
Well, if you insure buildings you should account for this increased cost of construction in your renewals.
The inflationary trend in property replacement costs isn’t going away anytime soon and if you don’t increase your limits of property protection you could be caught in a significant shortfall if a property loss occurs.
The inflationary trend that started over a year ago is pushing the costs of construction by up to 20% in most areas of the country and higher in some areas.
If you’ve been adjusting your building values by just a nominal amount, like 4 or 5 percent over the past few years you’re going to get caught in a serious gap.
$3,500,000 X 4% X 4% =
But using a 20% factor over two years
$3,500,000 x 20% =
$4,200,000 (actual replacement value) – $3,785,600 (what you did insure for) = GAP of over $400,000
Say for example you have an apartment building that had a replacement cost value of $3,500,000 in 2020 and you increased by just 4% in 2021 and 2022 renewals, that means today the insurance is $3,785,600.
Using a 20% inflation factor over those two years means that the real cost to replace the building is around $4,200,000 a difference of over $400,000!
What does this really mean?
It means that if your building is significantly damaged or totally destroyed you’ll have a $400,000 gap in your settlement proceeds or worse.
Now the flip side of this is that property insurance rates have been going up over the past few years.
The effects of wildfires and other catastrophic events destroying huge swaths of property in the US are making property insurance costs go up.
So you’ve got sort of a double whammy. Rates increasing and values skyrocketing all add up to higher costs.
What can be done about it?
That’s a good question – and depending on the values and occupancies we’re talking about the answer is probably a combination of risk engineering, risk control, risk sharing, and creative thinking.
The point is that doing nothing or renewing “as is” is dangerous for property owners, regardless of this is apartment buildings, commercial real estate, office buildings, warehouses, or any other type of commercial property.
One other twist.
There’s a lot of commercial property insured with co-insurance.
You’ll see on your policy declaration next to or near the limit of property insurance a co-insurance percentage – like 90% or 80% and maybe you’ve never understood what that means.
Well, briefly, it means that you must insure your property AT LEAST to a value equal to the replacement cost times the co-insurance limit, like 80%. Failing to do so will result in a penalty at the time of a claim where you will co-insure the loss with the insurance company.
This can be a real problem during high inflationary value jumps.
Say you insure a building for $1,000,000 and it has a 90% co-insurance.
Prior to this renewal, it was slightly underinsured already, before any consideration of inflation, and today that building has a replacement cost of $1,350,000.
There’s a partial fire damage claim amounting to $400,000.
Your settlement in that claim will be about $330,000 less your deductible – about $70,000 short – this is where you’re co-insuring this claim.
Now if the building was totally destroyed co-insurance doesn’t come into play but you still get whacked by underinsurance and only recover the $1M of coverage you have so you’re short now $350,000.
Also, not a good scenario.
What’s the solution?
This is where it gets sticky – during times of high inflation, it may make sense to have an appraisal done of your property so you know what the real values are.
Second, I’m not a fan of co-insurance.
Inflation or no inflation can lead to undesired claim results, so try and ensure to value as well as you can, and then change your policy to agreed value vs co-insurance.
The point is that just renewing “as is” or with a slight increase without really digging into the numbers can be hazardous.
You’ve got to be reviewing your statement of values, your policy terms and conditions and your risk controls every year before trying to negotiate better premiums.
If you’ve got questions or issues regarding the property insurance on your buildings, let’s connect and discuss where you are and what’s going on.
It might take some creativity to come up with a solution you’ve not been offered yet.