Protect Your Property
How much do you know about property and casualty insurance?
April 16, 2013
With regard to their businesses, entrepreneurs and executives should think carefully about risks to people and property. They should eliminate and avoid as many risks as possible and insure against the ones that remain.
This column will focus on property and casualty insurance and water damage. Property—structures, equipment, resources, inventory—can be destroyed, damaged, or stolen. People—employees, customers, guests—can be injured or die in accidents (i.e., casualties).
Before buying an insurance policy, one should determine whether it covers relevant risks or is structured to cap payments at extremely low levels. Some policy forms cover only those causes of loss that are specifically listed. Other forms cover all accidental causes of loss except those specifically excluded. Paying premiums for a policy that does not pay claims when you suffer injury is counterproductive.
Many insureds tend to under-insure their property, which prevents replacement after loss. Under accounting rules, the book value of a depreciating asset decreases each year due to use or obsolescence. The orderly expensing of an asset’s value is known as “depreciation.”
For example, suppose an organization buys a machine for $1 million, and it falls in value by $100,000 each year for 10 years until it has no use or residual value. Five years into its useful life, its book value is $500,000. The other $500,000 has been depreciated, or written off. If the insured machine is destroyed, unless the policy pays “full replacement cost,” the company will receive only $500,000 (i.e., its depreciated value). To make matters worse, the market price of a new machine may have increased to more than $1 million during the five years.
Insuring equipment for replacement value requires an estimate of value. Theoretically, one could inventory every business asset, have them professionally appraised, and have them reappraised annually. This is tedious and impractical. Thus, virtually no one will do it.
Unless one is scheduling and insuring only specific assets, one practical alternative to insure all or most business property is to calculate the replacement cost of the most vital, valuable assets and double it. That would finance the replacement of most of the business’ assets after a catastrophic loss.
Liability coverage for casualties could be substantial. Significant litigation costs could deplete the policy before the case is resolved. After legal costs, there might not be enough to pay damages if one loses the case. An umbrella policy provides a second tier of coverage and covers gaps in primary coverage.
When submitting a claim to an insurance company, it is essential to clearly document the loss. One should maintain receipts, blueprints and a photographic inventory. Because a catastrophe might destroy them along with the assets, one should store them electronically so they can be accessed and retrieved remotely.
An entrepreneur who operates a small service business (e.g., consulting) from a home office may not have adequate coverage. Standard homeowner’s policies do not cover business risks, and a homeowner’s business endorsement may be insufficient. A separate business owner’s policy can be very useful.
Most policies exclude coverage for special perils such as Earth movement (e.g., earthquakes, landslides, shifting) and water damage (e.g., flooding, sewer backup). Many of these risks can be mitigated by surveying competently and choosing relatively safe locations. For example, one can avoid earthquakes by avoiding fault lines and water risks by building or renting on high ground.
Surface runoff occurs when rain, melt water or other water sources saturate the soil to full capacity. In low-lying areas and buildings with basements, one should buy a quality sump pump and backup battery, pay for competent installation, and purchase pump failure coverage. Sewage backup can be prevented by the installation of a one-way valve.
Most people do not purchase flood insurance, or they buy minimal coverage. If flooding is possible, flood insurance is absolutely essential. Flood claims made under other types of policies will be denied. Applying to FEMA or hoping that Congress will approve “flood relief” is not a plan—it is a very bad last resort. If and when the government gets around to “helping” it will likely take a long time and provide a loan that recipients must repay. Flood insurance promptly reimburses insureds, and they do not have to repay it.
Editor’s note: This column does not constitute legal advice.