Commercial Property Insurance- What is enough?

The right commercial property insurance can ensure your business can bounce back in the event of a disaster or accident. With so many different policies and coverage types, it is hard to determine which one will provide the right coverage for your business. Replacement Cost and Actual Value Coverage will determine the how loss is calculated and the replacement of items after an unforeseen event, based on the value of the item at a specified time.

property insurance

Replacement Cost

Replacement cost policies cover the cost to repair or replace a building with materials of the same or comparable quality. This type of coverage replaces and repairs items to its identical state, so it does not include improvements required by building codes or laws passed since the building was built. It also does not include the value of any land and is determined by the amount needed to hire contractors and purchase materials to repair or replace a building.
Theoretically, the replacement cost of a commercial property insurance policy should be lower than its market value. Replacement cost only has to account  for building materials and labor to determine compensation. However, the costs of material and labor can fluctuate. This makes it possible for the replacement cost of a property to be higher than its market value.

Replacement cost policies offer more financial protection in the event of a loss. It does not take depreciation into account when determining compensations. However, this type of coverage is usually more expensive and may not be the best option for every property. Without continuous maintenance and renovations, the value of a building will generally depreciate over time. It may be better to opt for a less expensive policy that still protects the operations of your small business.

Actual Cash Value

Actual Cash Value covers the cost to replace or repair a property, similar to Replacement Cost. However, under an actual cash value policy there is a deduction in compensation to account for the depreciated value of the original property. Commercial property covered under an actual cash value policy will be replaced or repaired using modern construction techniques and materials. Actual cash value policies generally have lower premiums than replacement cost policies and may make more sense for particular types of properties.

The Difference

Replacement Cost and Actual Value aim to make your business whole again after a loss. The difference lies in how the loss value is calculated. Here’s an example that highlights the difference between Actual Cash Value and Replacement Cost.

A small business owner/cafe installed a large screen TV purchased for $1000 4 years ago. There was a theft and the TV was stolen.

If the owner has an Actual Cash Value policy:

The small business owner will receive the difference between $1,000 and the depreciation for the time he/she owned the TV. The insurance company determines the useful life of a TV is 10 years, so 10% depreciation would apply to the TV each year.

4 years x 10% per year = 40% depreciation

$1,000 x 40% = $400 depreciation

$1,000 – $400 = $600 Actual Cash Value.

So the payment from the insurance company would be $600 minus any applicable deductibles.

If the owner has a Replacement Cost policy:

The small business owner would receive the total amount it would cost to buy the same (or very similar TV) at a store today…with a receipt. Using the same example from above, the insured would receive 1 check for $600 which is the Actual Cash Value and with proof of purchase showing the same or very similar TV, he would receive a 2nd check for $400. Both checks total $1,000, or the Replacement Cost Value. The business owner must factor in a deductible, if applicable.

What’s Right for Your Business?

When deciding between Replacement Cost and Actual Cash Value for your commercial property insurance policy, it is important to review the exclusions carefully. The exclusions will determine if additional policies are necessary to meet your business’ specific needs. Also, some business loans have requirements on the type of coverage the business must have. Be sure to check with your lender for these requirements.

The specific elements of your business will also help determine which policy is right for you. For example, a store located in a very old building in a popular urban environment will not depreciate as quickly as a new office building located in a business park. The store is more location-sensitive and does not require a specific type of building to operate. An actual cash value policy with lower premiums may make more financial sense than a replacement cost policy with higher premiums.

If you are still unsure on the type of commercial property insurance that is right for your business, contact one of our agents at Wallace, Welch & Willingham. We will be happy to assist you in determining the right coverage for your business.

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