With the cost of everything rising, it may not be obvious that commercial property insurance is also severely impacted by inflation. Commercial property insurance covers rebuilding or repairing a commercial building(s) in a covered loss, including materials and labor.
If you are a business owner, you should ask yourself if you have recently reviewed your coverage limits and consider if adequate. If not, below are some essential things to consider. 
The Impact of Inflation on Commercial Property Insurance:
Depending on when you purchased insurance for your building, you may be severely underinsured, given dramatic increases in building material and labor costs. Many commercial property policies have a feature known as an inflation guard, but that amount is likely lower than the actual inflation we are facing today.
Carriers occasionally update the inflation guard rate, but as it is typically at 2 or 4%, it may not keep pace with the actual inflation rate, which some studies recorded at 19% in 2022 for the construction industry. This means that many commercial and residential buildings are likely underinsured.
What Happens If I Don't Have Enough Insurance Coverage on My Commercial Property?
One can assume that if the insured building is deemed a total loss, and there is less coverage than the cost to rebuild, then you will likely have a gap in coverage. (Assuming there is no replacement endorsement on the policy.)
But what if your building is partially damaged, and the coverage limit is greater than the cost of repairs? You may think the carrier will pay 100% of the claim, but that is often not the case. Carriers understand that the likelihood of a total loss is possible but infrequent. Still, to ensure adequate funds are available to cover the occasional total loss, they rely on everyone insuring their properties adequately.
Most insurance policies have a co-insurance clause within the policy. This clause means the amount of insurance purchased (the dwelling/building coverage) must be equal to or greater than a specified percentage of the replacement cost at the time of loss.
A standard co-insurance percentage is 80- 90%. If your coverage limit does not reach at least this percentage of the building's value at the time of loss, the claim payout will be reduced in proportion to the deficiency.
As an example of a covered claim with a coinsurance penalty:
- Commercial building insured at $200,000 with a 90% coinsurance clause
- The value of the building at the time of loss a determined to be $300,000
- $50,000 claim filed
- Claim payment would be reduced by nearly $13,000, not including the deductible
How are Coverage Limits Determined when Insuring Commercial Property?
Determining the appropriate insurance-to-value coverage (ITV) can be a challenge. This is because one business could be a warehouse, while another a law firm, each with very different specifications impacting the building's replacement cost.
For commercial properties, it is common for coverage amounts to be determined by one of several methods:
- Estimate based on current cost per square foot
- Get an appraisal from a third party
- Review records and adjust for inflation
These methods are a balance of efficiency and accuracy. Of course, no one wants to over-insure a property as that is a waste of money, but under-insuring is also a risk, given the co-insurance penalties.
What is factored into Calculating ITV:
Unfortunately, calculating ITV is challenging, given how quickly the economy and world events can change. However, the goal is to estimate as closely as possible how much it would cost to rebuild your commercial building, including the direct expenses of labor and material, and the indirect expenses such as consulting fees and engineering expenses.
Other factors may include:- changes in building codes
- removal of hazardous materials such as asbestos
- unique features within the building
Advise on How to Insure a Commercial Building:
Working with your insurance agency and carrier is one way to work toward an adequately insured building. Insurance companies can typically access the current cost per square footage rate or send an inspector to provide an estimate. That said, an inspector is not a professional appraiser, so if your building has unique features or customization, hiring an appraiser is in your best interest.
Another tip is to look at your policy and consider the amount of coverage in relation to current construction costs. If you are surprised by the coverage limit on your policy, it is likely time to talk with your agent.
