Legacy Digest

A Comprehensive Guide To Better Understanding Your Commercial Building Insurance

There are many reasons why individuals buy commercial real estate. Perhaps you own a business and you’re buying a new location so you can stop paying rent and have a place grow your business. Or, maybe your business is commercial real estate, and you’re buying it solely to lease out to other businesses. Whatever your reasons for owning it, a commercial building is ultimately an investment.

In order to protect the value of that investment, you need to purchase commercial building insurance. Here at Legacy Partners, our goal is to help businessowners understand their insurance so they know what risks they face and how insurance can help protect against those risks. Here’s a detailed look at commercial building insurance, and how it can help you protect your investment.

Understanding Building Coverage

Commercial building insurance is a subset of broader commercial property insurance (which can also cover things like your furniture, equipment, or other business personal property inside the building).

Fundamentally, commercial building insurance seeks to provide building owners with an amount of money to help pay for damages in case a specified set of risks causes harm to that property. While it may seem straightforward, there are a number of potential variables you should be aware of which make this insurance extremely complex.

In order to make sure your building is properly protected, you have to answer a number of different questions based on the exposures you face:

• What perils are covered?
• How much insurance do you need?
• What other building coverages should you consider?

What Perils Are Covered?

One decision you need to make is what types of harm are you trying to protect against. In building insurance, you need to choose between three potential options for the specified causes of loss, otherwise known as perils, that you will be protecting against. Those three options are called basic, broad, and special causes of losses, and each includes a specific set of perils.

Basic is the cheapest option, but it leaves you exposed to a number of potential perils where you won’t have any insurance coverage. If you have a burst pipe that causes $50,000 of water damage to your building, you likely wouldn’t have any insurance coverage for it and would need to handle repairs out of pocket.

Most people choose the Special causes of loss coverage form because it offers the broadest level of protection available. Instead of specifically listing the perils that it covers, it will cover damage caused by any peril that is not specifically excluded on the policy. Typically, this leaves only a small subset of exclusions like flood, earthquake, war, nuclear accident, landslide/mudslide, and sewer/water backup, some of which you can separately insure against by purchasing specific coverage.

How Much Insurance Do You Need?

When you purchase commercial building insurance, you will need to agree with the insurer on the amount of coverage that will be provided for a building limit. There are a number of factors that go into this calculation.

Replacement Cost versus Actual Cash Value

First, you need to decide whether you want insurance to cover the replacement cost for the building, or whether you are satisfied receiving a payout based on the actual cash value of the building. “Replacement cost” refers to the full cost of replacing the damaged building to make it brand new. If your building is completely destroyed, Replacement cost coverage is designed to provide you with enough money to completely rebuild it. On the other hand, “actual cash value” for a building is the replacement cost minus its depreciation due to age and wear, meaning you would receive less money for an older building, and it likely won’t be enough to rebuild.

While most people choose replacement cost coverage, there are some situations where actual cash value can be the best option. For example, if you owned a rental property that you wouldn’t rebuild if there were a fire, you may just want to insure it for the actual cash value if that’s sufficient to protect the cost of your investment.

Calculating a Building Limit

Since the replacement cost is important in either scenario, insurance carriers develop building limits by using a number of different software tools to help estimate the replacement cost. They look at the type of construction materials, the square footage, the special features of the building, and the software comes up with an estimate of replacement cost. While you can propose any limit you want, the carrier will perform its own calculations to make sure you are not too far off from their estimate of a building’s replacement cost.

Co-Insurance

The way that insurance carriers make sure you purchase enough coverage for the building is by applying a co-insurance penalty to any claims proceeds should you fail to carry sufficient insurance limits. Typically, you can choose from 80%, 90%, or 100% co-insurance, or you can try to eliminate a potential co-insurance penalty by selecting an agreed value option (essentially, agreeing with the carrier to carry 100% of their estimated replacement cost).

Example: If you have a building that would cost $100,000 to replace, and your policy has a 90% co-insurance requirement, you need to carry $90,000 for your building limit, or you could face a penalty.

When you file a claim for a loss, the insurance carrier will compare the actual building limit you’ve selected with the true replacement cost, and penalize you based on the shortfall.

Example: Continuing from the above example, if you had only insured the building for an $60,000 limit, and you had a $30,000 loss that was covered by the policy, the carrier would only pay you $20,000 of your claim. $60,000 / $90,000 = 66 2/3% x $30,000 = $20,000. The $10,000 you don’t get paid is the co-insurance penalty.

To avoid this, we typically encourage building owners to increase the limit every year to help keep up with the cost of inflation, and to do regular checkups to make sure that they are carrying sufficient limits.

What Other Building Coverages Should You Consider?

Regardless of the specified causes of loss that are included in your policy, you may want to consider adding a number of other coverages to help protect your building.

• Flood: Especially if your building is in a flood zone, you should consider purchasing a separate flood insurance policy to help protect against the possibility that a flood could destroy your building.
• Earthquake: If you live in a place that faces a risk from earthquakes, you may be able to purchase coverage for damage from an earthquake separately.
• Water/Sewer Backup: We very commonly see claims from water/sewer backup (water coming back up into the building from these systems and not coming in from the outside). These perils are not covered under a standard property policy. Fortunately, you can purchase coverage extensions which will provide coverage to protect against these types of backup claims.
• Ordinance & Law Coverages: You may also need to look into ordinance & law coverage to properly protect your building:
  • Coverage A: Pays for the value of the undamaged portion of a building that has to be demolished due to local laws.
  • Coverage B: Pays for the cost of demolishing that undamaged portion of the building.
  • Coverage C: Pays for additional building costs due to local ordinances which exceeds just the cost of replacing what was there before.

What Factors Affect The Cost Of Building Insurance?

Before you even purchase a building, you may want to consider what the insurance cost is going to be for that building. Most of what we discussed above will impact the pricing. For example, if you choose special causes of loss versus basic, your cost will be higher. The higher your building limit, the more you will pay. But other than these obvious factors, there are still a number of things to consider:

• Location: One of the primary rating factors is location. Insurance carriers evaluate everything from the closest fire hydrant / fire station to the crime score for the neighborhood when setting rates.
• Loss History: If a building has had repeated losses in the past, carriers are likely to charge more for the building insurance coverage because they view it as a riskier property.
• Alarms: You may be able to get credits to reduce costs if you have a central station monitored fire/burglar alarm system.
• Fire Sprinklers / Suppression Systems: Buildings that have sufficient fire sprinkler / suppression systems typically receive a credit to help reduce the premium because the risk of loss is lower.
• Age / Building Upgrades: Newer buildings are typically cheaper to insure than older buildings because they have less claims. Your insurance agent will likely ask you for the date of the most recent updates to the buildings plumbing, electrical, HVAC, and roof. This is partially to make sure older buildings are eligible for coverage with the carrier, but there can also be an impact on pricing.

If you are considering whether to purchase a building, our team at Legacy Partners can help you evaluate the potential insurance costs for the location so you can get a picture of your true costs of ownership.

Conclusion

Building owners need insurance to help protect the value of their investment in the building. There are a number of different options and factors to consider when thinking about how to best protect a building to meet your needs. To make sure you are properly protected, you need to evaluate everything from the building limit to the causes of loss you are protecting against, and so much more.

For personalized advice and comprehensive coverage options, contact Legacy Partners Insurance. As an independent agency serving all Michiganders, our licensed professionals are ready to assist you with all your insurance needs. Call us today to ensure your business is properly protected.