The owners of a new company found a building on the market for an affordable price, so they bought it.
Built in the 1940s to manufacture aircraft for the war effort, the metal structure had a large open space.
The company occupying this space was in the software development business and the building was much larger than it needed, but the price made it seem like a sensible move.
However, the owners got a surprise from their insurance agent about property coverage.
Insurance companies base limits of insurance on the cost of replacing a building exactly as it was before the loss.
The cost of reconstructing this old building was much higher than both its purchase price and that of other suitable properties.
The company did not need that much insurance, and paying the higher premium for it would have been wasteful, so the owners asked the agent for alternatives.
They wondered, what if we don't rebuild our building as it was?
Reasons owners may choose not to rebuild
- As was the case with the software company, the current building's design may be impractical. The company bought the building because of a good price, not because of its large open space.
- A business may decide to consolidate operations into another location that can absorb the work and generate efficiencies.
- Depending on the building's age, it may not meet current building codes, and local requirements for a new structure can add significant expense.
The standard Business Property insurance policy states that the insurance company will pay "actual cash value" — the cost of replacing the property minus an amount for depreciation.
The policy often offers an option to value a loss at replacement cost without deduction for depreciation. For general information on coverage options, see Understanding Home Insurance Coverage.
A business that chooses replacement-cost valuation will generally need to carry an amount of insurance equal to the cost of replacing the building "as is."
The insurer typically pays the difference between actual cash value and replacement cost only if the property owner actually rebuilds or replaces the property, and then only if that rebuilding is done as soon as reasonably possible after the loss.
Most policies also provide a small amount of additional insurance to help cover increased construction costs caused by newer building codes.
For projects and code-related construction considerations, review Insurance Options for Construction Projects.
Businesses that do not need an exact replacement of their current buildings should ask their agent about a functional building valuation endorsement. This endorsement establishes a limit of insurance between actual cash value and full replacement cost and allows a property owner to replace the building with one that fulfills the same function at a lower cost.
Also consider increased ordinance or law coverage to help cover the additional costs of meeting current codes. For broader business insurance considerations, see Insurance Options for Businesses and Employees.
With the right attention to coverage details, a business can obtain property insurance that meets its needs without paying for unnecessary protection; before finalizing a policy, discuss with an agent the specific options and limits that apply to your situation.
Frequently Asked Questions
What is actual cash value versus replacement cost?
Actual cash value pays to replace property minus depreciation, while replacement cost pays to rebuild without deducting depreciation when the owner actually rebuilds.
When does an insurer pay the difference between ACV and replacement cost?
The insurer typically pays the difference only if the owner rebuilds or replaces the property within a reasonable time after the loss.
What does a functional building valuation endorsement do?
It sets a coverage limit between ACV and full replacement cost so the owner can replace a building with one that serves the same function at lower cost.
Should I add ordinance or law coverage?
Ordinance or law coverage is useful to cover additional costs if new building codes require upgrades or changes during reconstruction.
Who should I talk to about these options?
Discuss your needs and options with an insurance agent who can explain endorsements and appropriate coverage limits for your business.