Given the array of risks organizations face today — from fires and natural disasters to terrorism and other manmade hazards — it is imperative that businesses have adequate insurance coverage to protect them when the unexpected occurs.

With the hard insurance market of the past several years, though, coverage has become a major expense for businesses today. And underwriters are demanding precise and detailed values before providing coverage.

When responding to the carriers' demand for financial information, organizations must use the right methodologies to determine how much coverage they need. But too often they 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 business interruption and property insurance coverage they need. Unfortunately, these figures are often inadequate and/or inaccurate, leading to insufficient coverage or overpaid premiums. When such errors are identified, underwriters will deny blanket coverage or apply restriction for items such as rental values, ordinary payroll, and pure extra expense.

Market appraisals provide a relatively accurate valuation of the purchase price of a given property on the open market. But usually following a catastrophic event, companies have to rebuild facilities, not simply purchase them. Therefore, a whole different set of assumptions and valuations must be used in determining the appropriate amount of insurance coverage. It's a matter of replacement costs versus market value.

What Will You Say When They Ask What Happened?
Executives who want to ensure that their organizations have the appropriate amount of property and business interruption insurance should begin by asking the following questions:

• How were our property valuations determined: using market appraisals and capitalization formulas or using detailed estimates of replacement values?
• Did the professionals who estimated replacement costs have forensic accounting, engineering, and cost-estimating expertise?
• Were business interruption values calculated using 12-month, fixed 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 business interruption, extra expense, and replacement costs?
• 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 goods at various points in the production cycle? Or, were numbers simply used from the company's balance sheet?