By Jonathan Theders, Chief Executive Officer, RiskSOURCE Clark-Theders
The Consumer Price Index (CPI) increased by 7% in 2021, marking the largest yearly increase in inflation since 1982, according to the Bureau of Labor Statistics (BLS). Unfortunately, we're all becoming familiar with the rising cost of groceries and dining at a restaurant. What you may be less familiar with is how inflation affects commercial property insurance.
Replacement cost, or value, is how much it would cost to replace or repair a building with the same or similar materials. It is based on the amount needed to hire contractors and purchase materials. The market value of a property is not the same as the replacement cost. Market value is the estimated amount that a property would sell for on the date of valuation and includes land. While a property's market value will typically be greater than its replacement value, we are now seeing a shift in the other direction. The main concern with high inflation rates is having an adequate replacement cost estimate on your policy.
Most property policies have a provision that accounts for a small percentage of inflation. However, the cost to replace a building today may already be more than the inflation guard on your policy. Labor and supply shortages in the construction industry have caused replacement cost to increase more, and more quickly, than usual. The Producer Price Index (PPI) for many construction materials, according to the BLS, increased between 10% and 30%, with steel at 127% in December 2021. This rapid increase in labor and supply costs means that the estimated replacement cost on your policy may not be enough to cover a rebuild if you had to file a claim today.
Many businesses only look at the fine print after a claim occurs, when it is already too late. Make sure you understand how various potential claim scenarios could play out and that you are not left on the hook for something you thought was covered. Make note of anything you don't understand so you can go over it with your agent. Also, it may seem obvious, but double check that the company name(s) and address(es) listed are correct.
There are some instances where it makes sense to have actual cash value or functional replacement cost coverage for a property, but most commercial properties will be best protected with replacement cost coverage.
Even with normal levels of inflation, your agent should visit the property or ask for detailed information on the property's construction. Structure and construction material specifics, such as floor and wall coverings, can alter the estimate by quite a bit. Most agents have an estimation tool that has default settings for specific structure types, such as an office building or retail store, but if your building differs from this, and most do, the estimate will need to be adjusted. Now, with unusually high reconstruction costs, you want to make sure that the estimate is done using current labor and supply costs. It may be a good idea to reassess this on a quarterly basis while current inflation trends continue.
Your agent is there to help you address many of the risks your business faces - use them as a resource. If you don't feel confident that you truly know what is and isn't covered in your policy, ask your agent to go over it with you. Even if you've recently renewed, make sure that your replacement cost estimate is adequate. Insurance markets will continue to change in the foreseeable future. Start discussing upcoming renewals earlier than you typically would, so you can be prepared.
