What it means
The core of a property policy is what it covers, how much it pays and what it excludes. Cover is usually written either on a named perils basis, listing exactly which events are insured, or on an all risks basis, which covers everything except a stated list of exclusions.
All risks costs more but leaves far fewer arguments at claim time. The valuation basis matters more than most buyers realise.
Replacement cost pays what it costs to buy an equivalent new item today, while actual cash value pays replacement cost less depreciation, which on a ten-year-old production line can be a fraction of what a replacement actually costs. Choosing actual cash value to save premium is the most common way businesses end up underinsured without knowing it.
Business interruption cover is normally sold alongside and often matters more than the physical damage itself. A fire that destroys $500,000 of equipment might cost $2,000,000 in lost gross profit while the site is rebuilt, and only business interruption cover replaces that lost trading income.
The indemnity period, meaning how many months of lost profit the policy will pay for, is the setting most often set too short. The coinsurance clause is the trap that catches unwary buyers.
It requires the business to insure the property for at least a stated percentage of its full value, commonly 80% or 90%, and if it does not, the insurer reduces every claim payment proportionally, including partial losses. Values therefore need reviewing annually, because building costs and equipment prices drift upward while sums insured usually do not.
Deductibles are the lever businesses use to manage premium sensibly. Raising the deductible from $5,000 to $25,000 reduces premium because the insurer no longer handles small claims, and a company with strong cash reserves is usually better off self-funding minor losses.
The judgement is about the size of loss that would genuinely hurt, not about minimising premium in isolation.
In practice
Real-world examples.
Example
A restaurant group insures its ten sites on an all risks basis with replacement cost valuation. When a kitchen fire destroys $180,000 of equipment, the insurer pays for new equivalent equipment rather than the depreciated book value of $60,000.
Example
A distribution business raises its deductible from $5,000 to $50,000 and cuts its annual premium by $38,000. It sets aside the saving in a reserve, calculating that it can comfortably absorb two or three small losses a year.
Example
A manufacturer's roof collapses under snow, halting production for five months. The physical damage claim is $700,000, but the business interruption element covering lost gross profit is $1,900,000, and the policy's six-month indemnity period just covers the shutdown.
Think of it
“Property insurance covers damage to your stuff-protection for physical property.
Formula
Calculation
Where a coinsurance clause applies: Claim payment = Loss x (Insurance carried / Insurance required) - Deductible, where Insurance required = Property value x Coinsurance percentage. Take a warehouse with a replacement value of $2,000,000, a policy with an 80% coinsurance clause, and a sum insured of only $1,200,000, with a $10,000 deductible. The insurance required is 80% x $2,000,000 = $1,600,000, so the business is carrying $1,200,000 of the $1,600,000 needed, a ratio of 0.75. A fire causes $400,000 of damage. The insurer pays $400,000 x 0.75 = $300,000, less the $10,000 deductible, giving $290,000. The business absorbs $110,000 of a loss it believed was fully covered, purely because the sum insured had not been updated.Case study
Seen in the real world.
Renwick Textiles is a fictional company created for this illustrative example. It had insured its mill for $3,000,000 when the policy was first written eight years earlier and had renewed it at the same sum insured every year without a revaluation, while construction and machinery costs had risen substantially.
A flood caused $600,000 of damage. The loss adjuster valued the property at $5,000,000 and, with an 80% coinsurance clause requiring $4,000,000 of cover, calculated that Renwick was carrying only 75% of the required amount. The settlement was reduced accordingly, and the company had to fund several hundred thousand dollars of the repair itself.
The illustrative point is that Renwick was not uninsured, and had paid its premiums faithfully for eight years. It simply never repeated the valuation exercise, which is a five-figure task that would have avoided a six-figure shortfall.
Watch out
Common mistakes.
- Insuring buildings for their market value or balance sheet value rather than rebuild cost. Rebuild cost includes demolition, professional fees and current construction prices, and can be well above or below market value.
- Skipping business interruption cover. The lost trading profit during a shutdown routinely exceeds the cost of the physical damage that caused it.
- Leaving sums insured unchanged year after year. Inflation in construction and equipment costs quietly creates underinsurance, which a coinsurance clause then turns into a reduced payout on every claim.
Questions
People also ask.
What is the difference between replacement cost and actual cash value?
Replacement cost pays for an equivalent new item, while actual cash value deducts depreciation, so an older asset settles for considerably less.
Does property insurance cover flood and earthquake?
Frequently not as standard, since both are commonly excluded and need to be added back by endorsement or bought as a separate policy.
How is the deductible chosen?
By deciding the largest loss the business could absorb from cash without difficulty, then testing the premium saving from setting the deductible at that level.
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