The Importance of Insurance to Value for Commercial Property Coverage

An estimated 75% of commercial properties are underinsured by 40% or more. One important element to keep in mind when purchasing or renewing commercial property insurance is to ensure coverage includes correct property valuations in order to have sufficient protection and prevent coinsurance penalties. Conducting accurate insurance-to-value (ITV) calculations is essential. Generally speaking, ITV refers to an approximation of the full cost to replace or restore insured property.

ITV inaccuracies are all too common, and may occur due to a wide range of reasons, including:

  • leveraging ineffective property valuation methods.
  • intentionally underestimating costs in efforts to secure reduced premiums.
  • being impacted by factors outside of your control, such as inflation.

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ITV explained

An accurate ITV calculation should be the amount of insurance a business obtains and the estimated value of its commercial property. It’s important to keep in mind that a property may be assigned several different values, including the following:

Market value: An estimate of what a property could be sold for in the present real estate market. The market value of a property is based on elements such as lot size, building condition and location desirability.

Assessed value: An estimate generated by the municipality where a property is located, typically used to determine local property taxes.

Replacement value: An estimate of the current cost to replace or rebuild a property. The replacement value of a property depends on characteristics such as:

  • material and labor expenses.
  • architect services.
  • debris removal needs.
  • building permit requirements.

Common approaches to accurately estimating this value include getting a property appraisal from a third-party firm, leveraging fixed-asset records that have been adjusted for inflation or relying on a basic benchmarking tool (e.g., dollars per square foot). While appraisals often require more time and resources than other property valuation methods, they are largely deemed the most thorough and accurate.

Consequences of property undervaluation

Businesses could face a number of ramifications if they undervalue their properties. Namely, they may lack sufficient coverage following property losses, forcing them to pay out-of-pocket expenses to rebuild. Depending on the severity of property losses and associated rebuilding operations, paying these costs out of pocket could lead to major financial setbacks and—in certain scenarios—bankruptcy.

Additionally, property undervaluation can sometimes result in coinsurance penalties. Most commercial property insurance policies include coinsurance clauses, which encourage policyholders to carry reasonable and accurate amounts of coverage. Under a coinsurance clause, a policyholder is subject to a penalty—generally, a reduced payout—if your coverage limit is not at least equal to a predetermined percentage (e.g., 80%) of the value of your property.


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Ways to improve property valuations

Here are some additional best practices businesses can review to help ensure accurate ITV calculations and improve your property valuation measures:

Find a reputable appraiser. Third-party appraisals offer reassurance that calculations were conducted by experienced and objective professionals. Be sure to find a firm that follows the Uniform Standards of Professional Appraisal Practice and the Code of Professional Ethics and Standards of Professional Practice from the Appraisal Institute.

Seek additional resources. There are additional industry resources, reference guides and validated tools available to help ensure accurate property valuations. Specifically, the Marshall & Swift Valuation Service Cost Manual is a tool widely accepted by insurers. This resource features more than 30,000 component costs across 300 building occupancies that can be referenced when conducting valuations.

Consult other parties. Determining the value of a property should be a team effort. Make sure to compile a variety of property data from multiple qualified parties (e.g., accountants, contractors, real estate experts, risk managers, insurance professionals and chief financial officers) when making valuation decisions.

Make updates as needed. Appraisals should be conducted at least every three to five years, and sometimes even more often. The frequency will depend on factors such as:

  • changing property exposures.
  • altered operations.
  • building upgrades or modifications.
  • the implementation of new technology or equipment on-site.
  • shifting market conditions and property construction trends (e.g., inflated labor and material costs).

Kapnick can help

Correct property valuations are critical in securing adequate commercial property insurance in order to stay protected when covered events occur and avoid potential coinsurance penalties. At Kapnick, the experts in our Real Estate practice group can help. Reach out to us at [email protected] or 888-263-4656 for more info.

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