Just when we thought things were getting better, record-setting rates of inflation continue to rip through the United States. As consumers ourselves, we’ve seen the affects at the gas pump, grocery store, and restaurants. And, while things like COVID-19 cases, lumber costs, and the unemployment rate have all fallen tremendously over the past 12 months, nobody can confidently predict what variant and supply chain issues lie ahead.
Nonetheless, shop owners have to prepare for “business as usual” even amidst these uncertainties. Even though the average gallon of gas is now equivalent to a 4 for $4 at Wendy’s, data suggests Americans have not slowed their plans to hit the road this upcoming holiday season. With Thanksgiving travel and the December holidays and New Years right around the corner, auto repair shops and other businesses should rev up for another busy season.
What does inflation have to do with insurance?
Why is an insurance company talking about inflation? Mainly because inflation could be negatively impacting your property coverage – the coverage responsible for protecting the most significant asset on your books. Generally speaking, the amount you’re covered for does not increase at the same rate as inflation. In some cases, it doesn’t increase at all. So, due to current economic circumstances, you could be severely under-insured and therefore severely impacted by property damage or a total loss situation.
Here’s what you need to know:
1. Don’t confuse your property’s replacement value with your market value
As it relates to property coverage, you need to keep a thumb on the replacement value outlined in your policy versus the actual cost to rebuild today. Unfortunately, property owners of all types (personal and commercial) confuse the replacement value listed on their policy with the market value of their property.
Replacement value is the cost to rebuild parts of or your entire building. It’s influenced by the construction industry’s supply of contractors and the price of materials at the time of rebuild. Replacement value is not the same as market value. Market value is generally thought of as the price you could sell your property for. It’s based on the current value of other properties in your area that are similar in size and features and is influenced by the competitiveness of the buyers’ market. Both of these numbers are volatile; however, you’ll find a very static replacement value outlined in your policy. When the replacement value on your policy does not reflect today’s actual rate of construction and material, you could be forking over a fair amount of your own cash to get back up and running.
2. The price of materials required to rebuild your property matter
According to the Associated General Contractors’ press release, the cost of buying materials necessary to rebuild a property in a non-residential area has increased by almost 21% from February 2021 to February 2022. If your building’s last replacement value evaluation took place before the pandemic, your policy might not reflect the actual cash you’d need if you suffered a loss.
Let’s look at an overly-simplified example: if your property was evaluated pre-pandemic with a rebuild cost of $600,000, let’s say 50% of that total cost to rebuild is labor, and 50% is for materials. 21% inflation on materials alone could have you paying $63,000 out of pocket. That’s not even considering what is going on with the labor market right now. Whoa!
We recommend owners revisit the Replacement Value of their building each year. Also, don’t forget about those other “buildings” you own. Outbuildings and other structures can also be associated with your property policy and can be included in the replacement evaluation. If you are a repair garage, you may want to consider including paint booth(s) in your building limit as well. Paint booths can usually be included in the value of a building as they are considered permanent fixtures. Property coverage on a building is typically less expensive than the alternative: business personal property (BPP) coverage. With paint booth costs soaring to $250,000 or more now, this little modification to your policy could cost you a few dollars today, and a whole lot of capital in the long run.
3. If you are under-insured, you could get hit with a co-insurance penalty
What happens when you need to make a claim and find out your building is underinsured? Well, it depends on how underinsured you are. Co-insurance clauses are often added to property policies by insurance companies in order to get insureds to carry the appropriate limits in relation to the value of their property. Co-insurance is designed to discourage insureds from “risking it.” When insurance companies tap into co-insurance in the event of a total or partial loss, underinsured policyholders will get hit with a co-insurance penalty.
Let’s say you procured a policy last year that insures your building for up to $600,000 with a $1,000 deductible and an 80% co-insurance clause. Today, the cost to rebuild is now $1,000,000. Yesterday, you experienced a partial loss worth $100,000 in damage. Due to your co-insurance clause of 80%, your building coverage should have been adjusted to $800,000 (80% of $1M). But unfortunately, it wasn’t. And because you’re currently sitting at 60% ($600,000 of $1M), you will get hit with a penalty. Because $600,000 is 75 percent of $800,000, your insurance carrier will likely only pay out 75 percent, less your deductible. So instead of receiving $100,000 for your building’s repairs, you will only receive $74,000 ($75,000 minus your deductible).
4. Consider the cost of codes and updates, especially if you operate an older building
On your policy, look to see if you have “ordinance” or “law” coverage of at least $100,000. In the event of a total (or even partial loss), you may be required to add building improvements to meet new codes. Having ordinance or law coverage can help pay for the costs associated with required improvements. Garage and property owners often renew policies with the same insurance provider year after year. Because of this, ensure your provider is considering the cost of codes and updates.
According to Guardian Fire Protection Services, owning a building that does not have a sprinkler system installed will cost $2 to $7 per square foot to install. If the building is historic, up to $10 per square foot. If you do not have ordinance and law coverage, your insurance provider may not allocate any funds to cover the required improvements to the property. Odds are, you’ll be footing the bill for those expenses.
5. Revisit the limit and waiting period on your Business Interruption coverage
Business Interruption insurance is almost always included in our business owners’ policies to protect against loss of income and wages during a rebuild. If your business can no longer continue operations, Business Interruption will cover those lost revenue dollars and wages that would have been incurred if your business was still operating at full capacity. On your policy, look for your coverage limit and waiting period. The coverage limit is the amount you’re covered for, which will either be up to a certain dollar amount or the actual loss sustained. The waiting period will be the amount of time until the coverage starts to kick in. This will either be from the moment the property is damaged or up to 72 hours later.
Another thing to keep tabs on is the employment rate within the construction industry. When there is a shortage of skilled labor, construction will likely take longer. During these times, you may want to consider extending the restoration period listed on your policy to help with losses associated with drawn-out construction.
6. Flood and earthquake is not covered on your typical property policy
If your property is in an earthquake or flood-prone area, you should absolutely have coverage in place specifically designed to cover those risks. Your average property policy does not cover damages resulting from flood and earthquake events.
If you do not own property in a flood or earthquake zone, we still want owners to seriously consider putting these policies in place. “100-year” events can impact those not normally affected. Too often we see business owners who suffer these losses call their provider, expecting help, only to find their provider will not cover the loss. Look to see if you have this on your policy and if it’s not, it may be something you want to consider.
Stay on top of your policy
The last thing we want is for business owners to invest their dollars into an insurance policy that does not fully protect them. If you lose your investment and are not fully covered, you could potentially be losing your business too. You may not be able to stop the rising cost of materials, real estate, and overall inflation – but you can make sure you are protected against it. It may be a good idea to look for these items in your policy and discuss with your team what would be the best decision moving forward.