Understanding the Importance of Insuring a Building to Value
When insuring a building to its true value, understanding the importance of setting the right building limit plays a crucial role. Factors such as the type of valuation, building construction, square footage, fixed equipment, unique building features, availability of building materials and building codes must be considered in establishing the appropriate coverage.
Factors to Consider in Establishing the Building Limit
Several factors must be taken into account when determining the building limit:
-
Replacement Cost Method
The most commonly used valuation method is the replacement cost method. It entails insuring the building based on the cost to repair or reconstruct it with similar materials and quality. Accurate determination of the replacement cost can be obtained through building cost guides, estimators, or consulting local builders. Market value and tax assessments are not suitable benchmarks for this purpose.
-
Actual Cash Value
This valuation method involves deducting depreciation from the replacement cost. Depreciation is calculated based on the property’s useful life, rather than following strict accounting depreciation rules. Adjusters can use the broad evidence rule, taking into account factors such as replacement cost, market value, and tax value to arrive at a fair settlement.
-
Functional Replacement Cost
Functional replacement cost is another valuation approach that factors in modified building costs, built-in equipment, demolition expenses, and relevant ordinances. For example, if a brick building is lost and replaced with a frame structure, functional replacement cost would be the appropriate valuation method.
The Impact of Inadequate Insurance-to-Value
Insufficient insurance-to-value not only results in reduced indemnification in the event of a loss but also affects insurance functionality and rate setting. Insurance rates are based on the assumption that buildings are accurately insured to reflect their value. Underinsurance can lead to inadequate premiums being collected and skewed rate calculations.