Accurate Valuation: Critical for Commercial Property Insurance

When purchasing or renewing commercial property insurance, it is crucial for policyholders to ensure their coverage includes an accurate property valuation. Doing so provides sufficient coverage and prevents Coinsurance Penalties in the event of a covered property loss.

It is vital to perform an accurate ITV (Insurance-to-Value) calculation. Generally, ITV refers to the total cost required to replace or restore the insured property.

Inaccurate ITVs can occur for various reasons, including policyholders using ineffective valuation methods, intentional undervaluation to lower premiums, or uncontrollable factors such as inflation. Despite these risks, such inaccuracies are all too common. In fact, insurance industry data indicates that approximately 75% of commercial properties are undervalued.

Given this reality, it is essential for policyholders to conduct proper commercial property valuations. The following details provide more information on ITV, explain factors to consider when determining property value and the dangers of undervaluation, and offer ways to improve property valuation measures.

ITV (Insurance-to-Value)

An accurate ITV calculation represents the ratio between the contracted insurance amount and the estimated value of the commercial property as closely as possible, ensuring appropriate protection in the event of a property loss. It is important to keep in mind that different valuation methods are used depending on the purpose, including:

• Market Value: This is the value at which the property could trade in the current real estate market. A property’s market value is based on factors such as lot size, building condition, and location desirability.
• Assessed Value: This is an estimate calculated by the municipality where the property is located. These values are typically used to determine the building’s property taxes.
• Replacement Value: This is an estimate of the current cost to replace or restore the property. The replacement value depends on characteristics such as materials and labor costs, architect services, debris removal requirements, and building permit requirements.

Generally, insurance professionals recommend using the Replacement Value of the property to perform an accurate ITV calculation. Common approaches to accurately estimating this value include obtaining a property appraisal from a third-party firm, utilizing fixed asset records adjusted for inflation, or relying on basic benchmarking tools (e.g., dollars per square foot).

While appraisals often require more time and resources than other valuation methods, they are generally considered the most thorough and accurate.

Factors Affecting Property Value

In addition to utilizing replacement value estimates within the ITV calculation, policyholders must consider the following factors to determine the correct asset assessment:

• Direct and Indirect Costs: Beyond direct costs like materials and labor, property valuation must include indirect costs such as consulting fees, engineering services, and other expenses not directly related to physical reconstruction.
• Building Aging: For older structures, valuations must account for additional construction costs that may arise from upgrading old building materials and equipment.
• Building Codes: Older properties may require specific compliance measures during the restoration process to meet modern building codes (e.g., plumbing improvements, energy efficiency upgrades, sprinkler system changes, and safety enhancements). These adjustments can further complicate construction costs and increase the property valuation.
• Property Accessibility: Properties located on steep terrain or adjacent to other structures may require shoring or other safety measures to ensure accessibility during demolition and reconstruction. These measures must be reflected in the property valuation.
• Building Specifics: Unusual structural features in some buildings (e.g., stained glass) may require specialized construction work, raising reconstruction costs. Therefore, it is important to include construction costs for these unique features in the valuation.

Consequences of Property Undervaluation

Businesses can face several consequences if they perform inaccurate ITV calculations and undervalue their assets. Specifically, a business may lack sufficient coverage after a property loss, forcing them to pay out-of-pocket to fully rebuild. Depending on the severity of the loss and the associated reconstruction work, paying these costs out-of-pocket can lead to serious financial setbacks and hardship.

Conclusion

Property values are always changing. This means it is essential to update property valuations regularly—preferably at least every three to five years. Property valuations may need to occur even more frequently depending on factors such as the changing nature of the property, altered operations, building upgrades or modifications, implementation of new technology or equipment on-site, shifting market conditions, and property construction trends (e.g., rising labor and material costs). Updating valuations is critical to securing sufficient coverage and appropriate commercial property insurance.