As the costs of construction materials have skyrocketed over the past year, many commercial property owners and developers have overlooked a key consequence of those elevated prices: increased commercial property insurance costs.
This state of affairs is somewhat understandable. The dramatic rise in material prices resulted in the real and immediate inflation of building and structure costs. In the minds of owners, commercial property insurance costs can sometimes take a back seat to those sudden upfront building costs. As policies come up for renewal, however, owners need to remain cognizant of the rising material costs and realities of the commercial property insurance market.
A hard look at rising construction costs
Not surprisingly, most of the increased construction costs in today’s market are a direct result of the work stoppages that occurred when COVID-19 shuttered manufacturing plants. While some argue that the pandemic’s influence on manufacturing is waning, the influences on material pricing still loom large.
For example, there has been an “epic shortage of lumber,” with the cost of lumber increasing over 430% in some areas. Similar price increases have been seen in steel and other metals, and in the concrete and cement jobs that rely on those materials.
So, what does all this have to do with commercial property insurance rates?
Increased commercial property insurance costs
When it comes to a commercial real estate insurance policy, there are two basic types: (1) those that cover replacement costs; and (2) those that cover actual cash value. Let’s take a look:
- Replacement cost policy: As the name suggests, these policies cover the actual and current costs to replace a commercial property that has experienced some sort of loss event. These types of policies are undergoing unavoidable premium spikes simply because replacement costs are tied to the material prices at the time a loss occurs. As long as material prices remain inflated, so too will policy premiums.
- Actual cash value policy: While it may seem like actual cash value policies are a better financial choice right now, that is likely not the case. These policies pay out replacement costs, minus depreciation. Depending on the age, location, and condition of the property, this can result in disappointing policy payouts – especially when current replacement material costs are so much higher than the depreciated value of the lost asset.
With either type of policy, however, consumers must be prepared to face increased premiums that are simply reflective of today’s increased material costs and the resulting increased risk to insurers.
Why not wait out this inflation period before renewing a commercial property insurance policy?
Given that the current inflation of material costs is likely tied to COVID, wouldn’t a commercial property owner be wise to hold off on renewing a commercial property insurance policy until after prices have normalized? Although this strategy may seem prudent at first blush, the risk involved is not likely to be worth the short-term savings.
Why is this the case? This strategy overlooks the fact that most commercial property insurance policies contain a coinsurance penalty. Most insurance companies require a property owner to insure their property up to a specific percentage of the total value of the commercial property. If a loss occurs and the owner is not insured to that percentage, the insurance company may assess a coinsurance penalty when the claim is filed. Simply put, if the policy does not reflect the current market value of the property (including in that analysis a reflection of current material costs), the owner could be hit with a painful financial penalty right as they’re trying to deal with a significant loss.
Is shopping insurance companies the answer?
While consumers are always advised to shop for the best rates and best policies, commercial property owners should be aware that the current building material inflation crisis is impacting insurers across the board. At this time, the most important differentiators between insurance brokers are in market knowledge, honesty, integrity, and long-standing relationships with quality underwriters. If you’d like an honest assessment of your commercial property risks in light of today’s material crisis, contact Roger for a comprehensive analysis.