Improper Valuation Creates Risks for Insureds

Lloyd’s underwriters and domestic carrier leaders are extremely focused on building valuation. RT Binding leaders and underwriting teams are committed to assisting retail agents and brokers with educating insureds.  

Accurately stating a building’s replacement cost or actual cash value with an adequate and current valuation has always been important for insureds.  High inflation and supply chain constraints have further complicated matters making proper building valuation more important than ever.

The consequences of an undervalued building could have big implications for insureds, in the form of potentially large out-of-pocket expenses. Accurately stating a building’s replacement cost is important in order to help ensure that clients have the level of protection they expect and need.

Common misperceptions with valuation

• Misperception #1: Purchase price or market value reflects an accurate value for a building’s replacement cost.
  
  • The price of the building or current market value may not be an accurate reflection of its replacement cost.
• Misperception #2: Tax and mortgage costs show a building’s value.
  
  • Assessed value for tax purposes can be vastly different from the cost of materials and labor to repair or replace building when it’s damaged.
  • Similarly, appraisals performed to establish loans are typically performed at the beginning of the loan term and not updated until the financing program is renegotiated.
• Misperception #3: Keeping a valuation as is, despite inflation, will be fine.
  
  • Property market dynamics vary, but if insured value does not increase over the course of a few years, there is a strong possibility it is undervalued. This dynamic is even more relevant in the current inflationary environment.
• Misperception #4: Buildings should be valued at the minimum amount required in the coinsurance clause.
  
  • Coinsurance clauses in property policies allow for a buffer in the valuation, to help protect the policyholder in a situation where the value fluctuates over the policy period. Insuring a building at the minimum amount required by the coinsurance clause can increase the risk to the insured because using the minimum does not allow for common material and labor cost fluctuations.

Below is a simple example of how a valuation change can negatively affect a property owner:

• A commercial office building insured for $600,000 when the owner purchased it appreciates in value a few years later and suffers a total loss from a fire, costing $1M to replace. The property policy has scheduled limits of $600,000, meaning the insurer will pay a maximum amount of $600,000 for the claim (additional co-insurance penalties may apply). The building owner therefore faces at least $400,000 in out-of-pocket costs to rebuild.

Proper Valuation Tips: 

• Scrutinize valuations. If your insured's building was a total loss today, what would it cost in labor and materials per square foot to replace it?
• Benchmark local valuations. If most other buildings are valued at $200 per square foot and your client's is valued at $75 per square foot, it may be appropriate to closely review building characteristics and use valuation tools to determine if the building is undervalued.
• Compare to historical valuations. Building-cost inflation and market appreciation change over time. If your building was properly valued five years ago, it likely is undervalued currently unless the value has increased at the rate of inflation over time.
• Use valuation tools and detailed building information. A number of reputable valuation tools can serve as guidelines, but property owners should make sure to adjust for site-specific features.
• Urge insureds to consider insuring to full value. Once an accurate valuation is determined, use this amount to help determine an appropriate policy limit. Setting the policy limit at the minimum allowed by the coinsurance clause could expose the insured to potentially costly out of pocket expenses in the event of a claim.

It’s important to communicate to insureds that replacement costs have, in most instances, drastically increased in today’s market. Using values from prior years presents insureds with a significant risk. Our team of educated commercial property professionals at RT Binding Authority is here to help. Contact an underwriter today!