Choosing Your Level of Coverage
There are three levels of coverage that determine the amount of money to be paid to cover the cost of the loss or damage to the property. It is critical to understand these three levels of coverage and their respective benefits. The three types of coverage are:
- Actual Cash Value (ACV): This type of policy pays to repair damages or replace your building or your possessions—minus a deduction for depreciation. “Actual Cash Value” is often offered at a lower price, but is a poor choice because construction expenses continually rise, and the ACV value of your property will be lower than its replacement cost, requiring you to pay the difference, which could be a substantial amount. (Sometimes this level of coverage is offered by insurers for properties that are considered “sub-standard.”) Note: This is not a recommended policy.
- Replacement Cost: This is the standard level of coverage provided under the REIN program. This coverage ensures that your rental building is repaired or rebuilt at the actual cost to replace it. It is important to note that the repairs or rebuilding costs covered are only up to the sum that your policy specifies. For example, if your policy limit is $200,000, but at today’s construction prices it may cost $300,000 to rebuild your building, the maximum payout would be $200,000.
In addition, you can only collect the face value of the policy if you rebuild the building. Assuming once again that in your policy the building is valued at $200,000. It burns to the ground. The insurer will pay up to $200,000 to rebuild it—but you must rebuild it to collect the $200,000. However, at today’s construction prices it costs $300,000 to rebuild it. Now, you have two options:- Decide to rebuild; collect the $200,000 and pay the $100,000 difference yourself
- Decide not to rebuild the building, or at least not to its original size and purpose, and accept a claim settlement based on the Actual Cost Value (ACV) of the original building. In most cases, this would be far less than the amount of the insurance you carry. You are still required to pay for debris removal and site clearing out of your settlement money.
- Guaranteed Replacement Cost (Optional): The Guaranteed Replacement Cost provision offers the highest level of protection as it pays whatever it costs to rebuild your building as it was before the loss or damage—even if it exceeds the total sum of the policy limit. This gives you protection against increases in construction costs.
 |
 |
 |
 |
Note to Investors |  |
|---|---|---|
 |
 |
 |
Even though a Guaranteed Replacement Cost policy may be a bit more expensive, it offers the best financial protection against disasters. |
||
 |
 |
 |
Generally, the “Guaranteed Replacement Cost” coverage is rarely available for commercial buildings. However, the REIN Prime Realty Guard policy offers this valuable optional protection! To qualify for GRC protection, submit a current rebuilding cost appraisal.
Co-insurance Clause
In view of today’s high construction costs, the co-insurance clause is a critical part of any discussion on insurance coverage. The co-insurance clause allows insurance companies to reduce the coverage of your claim if you do not insure to the full value of the property equal to today’s rebuilding costs.
When only a portion of a building is damaged by an insured loss (i.e. fire in the kitchen), and your building is not insured to the full replacement value, the insurer will apply a financial penalty against the claim. A simple way to describe this penalty is if you are only insured for half the property value, the insurance company will only pay half of the cost to make repairs and you will have to pay the difference yourself.
To protect yourself fully against such an event you can increase the value of your coverage or buy a Guaranteed Replacement Cost policy.
To avoid any unpleasant surprises you should have the rebuilding cost (including demolition and debris removal), estimated, and then increase your coverage accordingly. Your options are to hire an appraiser, consult a local builder, or contact your broker for help with such an evaluation or estimate. Ultimately it is up to you, however, to decide on the amount of insurance to carry.
Note: It is important to note that the majority of investors do not have enough insurance to replace their buildings at today’s construction costs. Although it costs more initially it always saves big-time when you need to file a claim.
Contact us for further information on these insurance issues.
Construction Rebuilding Costs
Once again increasing labour and materials costs of construction should prompt every investment property owner to ask three questions:
- What would it cost to rebuild my investment property at today’s construction costs?
- Is there a big difference between the cost of rebuilding and my level of insurance coverage on the building?
- Can it be rebuilt and occupied within 12 months?
The sharp increase in property values and construction costs usually means that the majority of property owners are seriously under-insured. This is particularly the case where real estate investors have not had their properties valuated in the past two years, and therefore, would not likely have had their coverage adjusted.
Whatever the reason for this gap in insurance protection, the result can be disastrous when the property sustains a substantial loss. Being underinsured in this situation might be compared to a person getting a $100,000 inheritance (i.e. the increase in the value of their property in conjunction with increased construction costs), which they then leave laying around the house in cash—unprotected. To be underinsured against rising construction costs is a huge risk that all investment property owners need to consider carefully.
Also, if you anticipate that you cannot rebuild and occupy the building within 12 months, it then becomes important to extend the indemnity period on your rental income coverage. An optional 24 month period of indemnity is available.
Call us for more details on the value of getting a Replacement Cost policy or a Guaranteed Replacement Cost policy, and the option of extending your indemnity period on your rental income coverage.
back to top