Three ways insurance carriers can cover and add value to a property
The value of a property is crucial to real estate companies, but it can be interpreted in different ways. It may pertain to the property’s market worth, cash flow, or anticipated appreciation over time. But how do insurance companies evaluate value? The answer is straightforward: they measure it by the replacement cost, or the amount it would take to rebuild the building in case of a loss.
Many property owners find this challenging since the replacement cost of a building in an insurance company’s eyes doesn’t always align with their value of the building. Depending on the market where a building is located, the market value of a property and the replacement cost can be very different.
Valuation is a critical component of real estate ownership, and most insurance companies use a tool called Marshall Swift Beck or MSB to help determine value. However, there are many variables that can make a significant impact in where that valuation comes out. There are cases where if the details aren’t entered correctly, a building that cost the developer $180 per square foot to build ends up coming out of an MSB report at $250 per square foot. This is where a good broker comes in – they can help you avoid such pitfalls and ensure you get the best possible valuation for your real estate property
While tools like MSB are helpful, brokers can take additional measures to ensure that the owner’s goals are being met. One such measure is to consider the three distinct ways that insurance carriers cover and value a property, based on the owner’s objectives.
1. Replacement Cost – The most traditional form of coverage
It estimates what the cost to rebuild the building would be and covers the building for that limit.
Example: If the building is estimated to have a replacement cost of $2.5M, the coverage on the building would be $2.5M. Any loss up to that limit is paid out in full up to the limit of coverage minus the deductible the owner chooses.
2. Actual Cash Value – A Cheaper Alternative to Replacement, Accounting for Depreciation
Example: If you take that same building that has a replacement cost of $2.5M and there’s a loss, the depreciation of the damaged portion of the building is factored into the payout for the loss. If you have a roof that’s estimated to cost $400,000 to replace but is 10 years old, the insurance company would factor in the depreciation over 10 years, subtract that amount from the $400,000, and then pay the resulting amount minus the deductible.
3. Stated Loss Limit – Doesn’t look at the cost to rebuild or depreciation
Stated loss limit is the most overlooked form of coverage. This coverage simply allows the building owner to state how much coverage they want for the building in the event of a loss. This is commonly used in situations where the market value of a building is lower than the replacement cost.
Example: If you take that building at $2.5M, the owner could say he/she only wants $1.5M of coverage. In the event of a loss, up to $1.5M can be paid out, but the payout is capped at that limit.
How is your broker helping you navigate the various forms of coverage and ensuring the coverage you have meets your goals? If you have questions about valuations and coverage forms, reach out to an MMA advisor.