Are you adequately insured? Rising prices can impact rebuilding costs

Apr. 11, 2021

If you suffered a partial or total loss to your property, would you be adequately covered to rebuild and continue operating? That question has taken on even more urgency with the recent increased cost of raw materials and other factors impacting the overall price tag of a possible reconstruction effort.

For instance, lumber prices have hit a record high, up more than 170 percent over the past 10 months, according to the National Association of Home Builders, as reported in Realtor® Magazine. CNN reported in February that copper prices had climbed to their highest level in a decade. The increased cost of resin also has dramatically impacted the cost of PVC pipe.

However, it is not just the jump in raw material prices that could impact a rebuilding project. The fact is that contractors are having difficulty finding qualified help. Supply chains are challenged as well. In addition, with 2020 having been a record year for hurricanes, storms, wildfires and then the frigid cold snap in the South that resulted in massive power outages and burst pipes, the demand for those supplies has never been higher.

“This is the hot topic this year,” says ARA Insurance Preferred Agent Terry Kunst, CIC, LUTCF, vice president, Mount Pleasant Agency, Mount Pleasant, Mich. “These increased prices will be more dominant as the year progresses. What we are seeing in the construction area is that people are still building because of the pent-up demand for housing and commercial buildings. If supply is not there but demand is high, the price will go up. It is basic economics.”

The increase in raw material costs alone “has a big impact on the insured value of the building,” Kunst says, adding that “now, because of the tariffs and the destruction of the supply chain, lumber is very expensive. Labor costs have gone up, too. As an example, if we insure a building for $100,000 because of the cost of the materials, it may be 50 percent higher now to rebuild, depending upon market conditions.”

The coronavirus (COVID-19) pandemic has created additional challenges. “If workers are exposed, the entire work area has to be cleaned, adding another dimension to the reconstruction,” says ARA Insurance Preferred Agent Gates Goza, owner, the Goza Agency, with locations in Hattiesburg, Miss., Calhoun, La., and Parkdale, Ark.

“If you add in all these other factors besides raw material costs, it means more time and more delays,” he says. “Timing is everything when it comes to business loss. If you have delay after delay, all of that can add to the costs. It offers another challenging layer, and time is money,” he says.

So, what does all this mean to you as a rental business owner?

“If rental business owners are underinsured regarding their replacement cost coverage, that could be an issue,” Kunst says. “ARA Insurance offers an automatic increase in the building’s value — 2 percent per year. However, if you are starting low, that 2 percent will never quite catch you up.”

The topic of replacement cost coverage is “talked about virtually every year during the renewal time,” says ARA Insurance Preferred Agent Tom Rensch, CIC, consultant, Cornerstone Insurance Group, St. Louis. “Some rental operators are very in tune with it and cognitive of it. Then there are others who aren’t as overly concerned about it because they think they can get things built and done for less money.”

Rental operators and business owners in general often tend to want to use market value vs. replacement cost, Rensch says. “Let’s say a rental operator paid $300,000 for his building and his piece of property. Naturally, he does not want to insure it for more than what he paid for it. This conversation happens with business owners in all industries. However, he has a building that will cost $500,000 to replace. We have to get into the size of the building, the construction type and quality, and make sure we are establishing a proper starting point with respect to the replacement costs.”

“The replacement cost of a building and market value can be very different,” Kunst says. “If you are in a plush area, it may be $1 million to replace the building, but no one is buying it for that and you are insured for $100,000. That wouldn’t do much if it is destroyed, but it is closer to what someone would pay for it, not what it would cost to replace it.”

Kunst, an independent agent, also writes homeowner insurance. “We used to figure $100 to $125 a sq. ft. for residential construction, but our homeowners insurance companies are telling us that if we don’t use $150 a sq. ft. or more, they are questioning what numbers we are using. One of our contactors is telling us that $200 to $250 a sq. ft. is needed for a standard home where they were $150 a sq. ft. several years ago,” he says. 

While a rental operation is different from residential construction, the bottom line is that the price per sq. ft. has increased.

To gain insight into the actual cost of rebuilding, Kunst, Goza and Rensch suggest consulting a contractor.

“Rental owners would need to have a fair idea based on a local contractor on what they would charge to replace the building or buildings they have in their policy. We can run a cost estimator, but we are not contractors. We can give them an indication,” Kunst says.

The agents interviewed also underscore the importance of other types of coverage that are involved when either a partial or a complete loss occurs, including:

Debris removal coverage. “ARA Insurance does provide debris removal,” Kunst says. “When you have a loss, you have to bring in the dumpsters, the roll-offs and the dozers. You have to clean up the site. ARA Insurance automatically gives you $250,000 for debris removal. If you don’t have enough for debris removal, then whatever that cost is will come out of the figure you have to rebuild the building. If you have a $1 million building and $50,000 in debris cleanup coverage, the actual cost of that debris removal could be $100,000. That extra $50,000 could come out of your building replacement costs. ARA Insurance has a very good limit. Most commercial policies are $10,000 to $25,000. ARA Insurance is very good in that direction.”

The amount of debris removal coverage is becoming even more important as “the cost of handling debris has gone up dramatically. The landfills are increasing their rates,” Goza says.

“With ARA Insurance increasing that coverage to $250,000, it is a nice additional provision,” Rensch says.

Business income coverage. If there is a partial or total loss, business income is usually lost, yet there still are extra expenses in just trying to stay operational. “If you have a loss, you need to have enough coverage in case your business goes down — to get the money you need to continue operating. With ARA Insurance, you can pick your limit on that. A rule of thumb is to have 50 percent of your gross rental revenue covered. If your rental revenue is $1 million, you should have $500,000 in business income and extra expense coverage,” Kunst says.

This coverage takes on additional importance because, with the supply chain challenges and other factors, “you might not be able to complete the reconstruction in an estimated time,” Goza says. “The business income coverage allows you to go to an alternative site or rent an additional site where you can operate while your building is being remodeled or rebuilt. A plus is that business income and building replacement are the least expensive parts of the policy.” 

Blanket coverage. With ARA Insurance, “we have the ability to blanket the building limits of coverage,” Kunst says. “If there are several locations and more than one building, we insure each building separately and add that number up. That gives us an aggregate total for all the building coverages at all the locations. If that rental operator has three buildings at $100,000 each at three locations, we can put in a blanket of $300,000 coverage. Then that operator will have that amount of coverage at any one of the locations or for any catastrophic loss, so he won’t have to borrow for the location that was destroyed. It is important wiggle room.”

Rensch agrees that blanket coverage offers “more flexibility when you have multiple buildings. However, the one thing to address with a blanket limit is that it doesn’t mean you can underinsure your buildings and throw a blanket limit on it to save premium. Having blanket limit doesn’t mean you don’t have to insure the value. It just gives you flexibility,” he says.

No co-insurance. “Another thing of extreme importance with ARA Insurance is that there is no co-insurance requirement,” Kunst says. “Most insurance companies require you to insure 80, 90 or 100 percent to the replacement value. ARA Insurance does not require that. So, if you have a $100,000 building and you have co-insurance that required 80 percent coverage, you would have to carry $80,000 coverage on that building at all times.”

Because ARA Insurance does not have a co-insurance policy, “you never have to worry about getting paid partially on a loss because that provision doesn’t come into play. Let’s say you have a limit of $500,000 on a policy and you have a $100,000 claim. With ARA Insurance, you will get paid $100,000 less your deductible,” Rensch says.

However, with co-insurance, “what can potentially happen is that policy should have been written for $600,000 vs. $500,000. And you had a 100 percent co-insurance, so you are insuring 100 percent of the value. Now you have a ‘did over should’ — you carried $500,000 but should have carried $600,000. You take $500,000 divided by $600,000 times your co-insurance provision, which is 100 percent. That is the percentage they will pay you out of that $100,000 loss. Co-insurance goes away on a total loss. The limit is the limit. If you have a total loss, the most they will pay is $500,000, but if a total loss will cost $600,000 to replace it, you have to pick up the extra $100,000,” he says.

Steps to take now. “I always say nothing is a problem until claim time,” Rensch says. “Therefore, my advice would be to take a good hard look at your building limit and have a discussion with your insurance professional about it. This is a time when you don’t want to be underinsured on property coverage. Property coverage on a rental policy is typically not your biggest premium driver on a rental insurance policy. It is important to make sure you are insured properly and you are insuring the value. In the event of a property loss, or what I call ‘your stuff,’ you want it back, so it is important to talk with your insurance professional now so if a claim does happen you are properly insured.”

With all of these cost and potential delay challenges hitting at the same time, rental operators need to remember that “what they thought they could build in the time and manner they thought they could do is probably not reality now. They need to be able to change from that thinking and make sure they have the coverage they need in case the unthinkable happens,” Goza says.

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