This can have significant implications if an insured's policy is subject to coinsurance or margin clause provisions. With a more than 10 percent increase in the cost of building materials over the past 12 months, owners who simply renewed last year's policies without reviewing their coverage for replacement costs could find themselves under-insured in the case of a loss. While spikes can come into play in the short-term, the long-term impact of rising construction and material costs also must be considered.
With the costs of building materials such as steel and cement rising sharply in recent months, the expense of replacing an existing property has shot up. Owners who haven't taken higher replacement costs into account when buying or renewing one-year insurance policies for their properties this year may be underinsured.
Wall Street Journal, 8/03/2004
The recent rise in materials costs should serve as a wake-up call to property owners to review not only their insurance coverage but also how coverage amounts were calculated. For example, many organizations use valuations based on market appraisals or capitalization formulas or simply increase numbers based on the previous year's assumptions to determine the level of property and business interruption insurance they need. Unfortunately, such amounts are often inaccurate.
Market appraisals provide a fairly accurate valuation of the cost of purchasing a property on the open market. But after a catastrophic event, companies have to rebuild facilities or parts of facilities — not simply re-purchase them. With the significant rise in building materials costs, it is essential that coverage amounts use up-to-date figures, assumptions, and valuations.
It's essential for property owners to keep their premiums up-to-date to fully cover replacement costs. Insurance companies typically have inflation-guard protection in policies to meet full replacement values in case disaster strikes. But the index is tied to national or regional trends and doesn't necessarily reflect specific areas.
Reno Gazzette Journal, 7/31/2004
Executives who want to ensure their organizations have the appropriate amount of property and business interruption insurance coverage should begin by asking the following questions:
- How were our property valuations determined: using market appraisals and capitalization formulas or detailed estimates of replacement values? When was the last time the figures used to calculate replacement values were updated?
- Did the professionals who estimated replacement costs have forensic accounting, engineering, and cost-estimating expertise?
- Were business interruption values calculated using 12-month estimated net profit and continuing expense values only or was the anticipated maximum business interruption loss (AMBIL) also calculated?
- Were ancillary items such as rental values, ordinary payroll, and pure extra-expense exposures properly and accurately determined?
- Do we have sufficient documentation to support the calculations we used to determine replacement cost, business interruption, and extra expense?
- Did we use a consistent methodology in determining all our exposures to ensure the proper limits were determined?
- Were three appropriate calculations used to determine stock/inventory values: raw-material, works-in-progress, and finished goods to accurately capture replacement costs of the raw materials and the work-in-process and net selling price on finished goods? Or were numbers simply used from the company's balance sheet?
If you answered "no" to any of these questions, it may be time to reconsider the valuation of your facilities for property-insurance purposes. To properly calculate replacement values of buildings, it is essential to seek the services of construction industry professionals, who can review a site and provide detailed replacement values using construction-industry estimating techniques. If you have multiple facilities, it may be most cost-effective to review a representative sample of properties.
In addition to reviewing property replacement values, it is important to ensure you likewise have the appropriate amount of business interruption insurance. You should obtain detailed, location-specific estimates that take into account rental values, ordinary payroll, pure extra expense, and the time necessary to replace the property.
Professionals in Marsh's Forensic Accounting and Claims Practice help ensure you have sufficient coverage. With experience in engineering, forensic accounting, and insurance claims, Marsh professionals provide accurate and up-to-date property valuation and business interruption calculations.
For property damage values, Marsh's Construction Consulting professionals calculate replacement costs using methods certified by the Association for the Advancement of Cost Engineering (AACE), the industry's leader in cost estimating, cost control, business planning, project management, planning, and scheduling. And Marsh's forensic accountants and claims specialists bring a deep knowledge of insurance losses and how to account for them.
For business interruption and extra expense values, Marsh's forensic accountants and certified public accountants understand first-hand the value of accurate pre-loss assessments. Marsh provides detailed, location-specific, estimates for business interruption valuation and anticipated maximum business interruption losses, taking into account the industry in which you operate.
In the event of a loss, Marsh can assist you in the preparation of claims and negotiations with your insurer. Should legal assistance be required, Marsh's litigation support professionals have extensive litigation experience to help protect you from significant loss exposure. Marsh professionals will not only expedite the claims-preparation process, but also can be your advocate to help ensure maximum recovery.
If you have any questions or would like additional information, please contact us.
