Replacement Cost vs. Actual Cash Value

A key point in the consideration and purchase of property insurance coverage is the choice of replacement cost coverage versus actual cash value settlement. This is similar to what is available in many homeowner's policies. If you are insured for replacement cost, you will tend to get more money for your property loss, as opposed to being covered only for the depreciated actual cash value of the property at the time of loss. The concept of functional replacement cost is normally used as a preferred method when insuring machinery, production equipment, and other contents to save on insurance premiums. This means that destroyed machinery will be replaced with less expensive equipment, rather than replacing exactly what was lost, as is usually the rule with insurance.

Coinsurance

To help keep rates stable, insurance companies have put a coinsurance clause into most property policies. However, this clause can penalize you for being underinsured, so if you must include this clause, be sure that your coverage limits are adequate (i.e., that you are covered up to at least the coinsurance percentage). For example, if your building has a replacement value of $100,000 and you have an 80% coinsurance clause, you must carry at least $80,000 of coverage to avoid being penalized. If you are carrying $70,000 of coverage and have a $10,000 loss, you will only be covered for 7/8 of the loss ($70,000/$80,000) and have to pay 1/8, or $1,250, out of your own pocket. The replacement value is what counts here, not what you paid or the amount of your mortgage, and this value is determined at the time of loss, so you will need to monitor your coverage and keep it current.

Types of Coverage

Property insurance comes in Basic, Broad, and Special forms, with coverages as follows:

Basic coverage usually includes:

• fire
• lightning
• riot
• Explosion
• vehicles (not owned or operated by you)
• smoke
• hail
• aircraft
• wind
• vandalism and malicious mischief
• sprinkler leakage
• sinkhole collapse
• volcanic action

Broad coverage usually covers the above plus:

• freezing
• falling objects
• weight of ice and snow
• glass breakage
• water damage
• artificially generated currents

Special form covers everything not excluded by the policy and so is the most comprehensive of the standard policies. Under this form, the insurance company must find an exclusion to deny the claim. This is also the only form that provides theft coverage.

Other coverages which you may need to consider and which are generally excluded above are:

• earthquake
• flood
• building ordinance and law—covers the increased cost to repair or replace your building because building codes require upgrading to current requirements.
• glass
• construction or builder's risk—used during construction
• pollution
• business income and extra expense—designed to replace the loss of profit and cover the ongoing expenses of your business after a loss occurs, and until you are back in operation.

When considering limits on coverage, you should look into blanket coverage as opposed to separate property limits. This lumps the building and contents together. It is particularly useful in a manufacturing operation or one where your product moves between locations.

Business Owner's Policy

If you qualify, the Business Owner's Policy may be your best option for very broad coverage. This policy is actually a package that can include coverage for your building, business property, and property of others. The liability coverage is very similar to commercial general liability policies in that it contains most of the same coverages, plus nonowned and hired auto coverage is available as an option. Optional coverages can be added for glass, signs, machinery, and employee dishonesty.

These policies are normally for small retail businesses, but some companies offer a form of this coverage for service businesses. They are designed for business owners and landlords with moderate insurance exposures. Check with your agent to see if this is an option for you. If so, shop around, because prices vary significantly from company to company. However, if you can get this coverage, it may be worth it.