This may seem like a funny or unusual title, but what I want to describe in this video and post the three common problems in commercial property insurance and when all three corners of this Bermuda Triangle line up, it spells trouble for the real estate investor or owner which I’m going to describe, coming right up.
Okay so what do I mean by the Bermuda Triangle of Property Insurance?
These are situations I encounter pretty often when a prospect comes to me with a building or group of buildings, and if goes unaddressed any claim that occurs can be a nightmare.
So it’s better to be educated on this to avoid problems. Here are the top three corners of the Bermuda Triangle that concern me most often:
The first common problem in property insurance is Property Value
Too often I find commercial property insured for a figure well below what it would cost to rebuild the building today if it was destroyed. Building values should represent the 100% replacement cost value.
It may be that the building limit of insurance was guessed at, it was never updated for inflation, or the building owner wanting to not pay a lot for insurance just decided it was better to underinsure the building to save money, figuring they would never suffer a total loss and if they insured for 50% less than its actual value they’d be okay.
Today, with the cost of construction materials and labor rising over the past two years it’s not uncommon for buildings to be underinsured by 25% or more.
The second corner of the Bermuda triangle of property insurance is co-insurance,
Co-insurance is stated as a percentage – commonly 80% or 90%.
Unfortunately, it’s often misunderstood by insureds and their insurance brokers and when combined with the under-insurance I just discussed this becomes a really serious problem.
Co-insurance is used by insurance companies to encourage you, the property owner, to insure a building or other property to a reasonable value and not underinsure it.
If you underinsure a building then you are agreeing to co-insure it with the insurance company and in the event of a claim, you agree to also pay a share of that loss.
Here’s an example – let’s use the property owner I mentioned earlier who elects to insure their investment property that’s worth $1m for $500,000.
Their real estate investment property policy has an 80% co-insurance requirement.
They have a fire claim which partially damages the building which is going to cost them $300,000 to remediate and rebuild the building.
The real estate investor thinks, no problem. I’ve got $500,000 of insurance I’ll get $300,000 from the insurance company and rebuild. Unfortunately not true.
Due to the 80% co-insurance clause, the investor’s actual recovery will be $187,500 less the deductible in the policy. (The formula for figuring this out is what we call: did over should).
The insured “did” insure the property for $500,000 they “should” have insured it for at least $800,000 (the full value of $1M x 80% co-insurance limit).
Assume a $10,000 deductible and the real estate investor gets $177,500 from their insurance company and pays $122,500 out of pocket as their “co-insurance share” to settle the $300,000 claim.
Not a great result especially compared to how little they probably saved in premiums over the years for underinsuring.
The third corner of the triangle is something called Ordinance & Law coverage, and it’s not talked about that often, but I think it’s a particularly difficult issue with older buildings –
Which could be anything more than 25 years old. Let’s use an example here as well.
You own an apartment building that has 25 units it was built 50 years ago and it suffered significant damage due to fire and smoke.
Let’s assume the building value is $5,000,000 and it was insured for $5,000,00.
Everything sounds good, no problems, right?
Well, you go to apply for a building permit and the building department says that because of the level of damage that occurred, you now need to upgrade the building to today’s standards or code requirements.
That may mean the building must be sprinkled, new fireproof doors must be installed in each unit, there must be an elevator and ramps to comply with the ADA, and so forth.
You think, great, I’ll get all these upgrades with insurance proceeds.
Unfortunately, your insurer will not pay for those upgrades unless you have this Ordinance and Law coverage.
The insurer’s obligation is to replace the damaged property with similar new property – not to upgrade it, and these upgrades could be costly – like hundreds of thousands of dollars costly to millions, and they’re going to come out of pocket.
So for real estate investors, that’s the big Bermuda Triangle issue of property insurance we often see.
But to be honest, there are several other issues to be aware of that I’ll go into further detail on in other videos and include valuation clauses, deductible structures, insufficient business income protection –
Otherwise known as loss of rents insurance, equipment breakdown, and something that’s becoming more and more prevalent to talk about – Flood and Earth Movement coverage.