If You Rebuild It, They Will Return

Whether youre building a new facility or are the proud owner of an existing site, you must always have a plan for restoring your business in the event of serious fire loss or storm damage.

Astute owners stay in tune with current construction pricing and building trends to maintain insurance coverage for changing reconstruction costs. Three factors have significant impact on the cost to repair or rebuild a facility:

• General inflation in building or construction costs 
• Building-code changes 
• Demand surge

Inflation

Because development fees fluctuate with costs of labor, building materials and structural requirements, property insurance needs to be updated periodically. Planning to adjust the amount of property insurance every year to offset inflation is a good start, provided you are looking at the correct inflationary index.

When you hear about inflation in the news, the focus is usually on the consumer price index, which identifies prices paid by urban consumers for a representative basket of goods and services. This is quite different than what youll need to build or rebuild your facility. For construction, the appropriate index to keep in mind is the building cost index (BCI) or construction cost index (CCI).

The BCI and CCI include a mix of labor, materials and energy costs associated with construction. While labor costs have had only modest increases over this period, the prices of building materials, particularly for cement and steel, and energy costs have increased dramatically.

Its important to understand the difference in inflation measures by each index. While consumer prices rose about 25 percent in 10 years, construction costs increased between 42 percent and 50 percent, depending upon development type and U.S. region. In 2004 we saw a particularly large jump10 percentin construction pricing.

Some companies offer an inflation-guard adjustment in property-insurance limits to automatically increase coverage by a fixed amount, such as 1 percent to 3 percent per quarter. Alternatively, a company may provide an insurance limit above the estimated replacement cost of construction as a precautionary hedge against original estimate errors and inflation during the policy term.

Many companies request or automatically make value adjustment on renewal based upon BCI or CCI changes during the preceding policy year. These can help offset inflation but arent precise and may not be adequate during periods of rapid construction-cost changes. Work with your agent to determine what inflationary protections are already built into your policy and be prepared to request adjustments when necessary.

Building Codes

Keeping insurance limits in line with inflation enables you to repair and replace property with like quality. But it wont account for changes required because of state or local building codes. These codes regulate construction standards and specifications primarily to protect people from dangers of fire and building collapse. In addition, the Americans with Disabilities Act of 1990 added standards for new construction and alterations.

Building codes are updated frequently and impact costs of new construction or repair. They can dictate the type of materials used for engineering standards with respect to wind resistance and seismic safety, and fire-protection systems. For example, repairing or replacing damaged structures to current code standards may require roof or rolling doors meet substantially higher wind-load requirements than previously, or the facility may need to be retrofitted for an automatic sprinkler system.

Compliance with new life-safety codes is not enforced on all repairs but is often triggered by major claims, such as when 40 percent to 60 percent of a structure has been damaged. ADA access requirements may be triggered by almost any work deemed to be substantial, and permits for other construction cant be made until they are met.

Insuring increased reconstruction costs for building ordinance requires more effort than simply updating limits for inflation adjustments. First, automatic adjustments and annual renewal evaluations are based on construction costs from previous years, but they dont reflect code upgrades. Second, property-insurance policies exclude or limit amounts that may apply to the increased costs to repair damaged property due to building ordinance. A $100,000 limit for increased construction costs to bring damaged property to code is typical. Insurance policies can usually be amended to provide higher limits of coverage for an additional premium.

As you can see, keeping current with construction costs isnt enough to ensure adequate insurance limits. You need to be aware of changes in local building requirements that add to reconstruction costs. A close relationship with a knowledgeable contractor and good communication with your insurance agent on significant changes is advised.

Demand Surge

Demand surge can also affect your coverage. After a large disaster or catastrophe, construction material and labor can temporarily be in short supply, inflating construction costs. The larger the disaster and damage to property, the greater the magnitude of demand surge.

For example, a windstorm causing $5 billion in property damage may also bring a 5 percent demand surge in construction costs, while a $40 billion loss might result in reconstruction costs increases of more than 20 percent. Protection above the current estimated cost to replace your facility cushions against unpredictable inflation.

Delays in the rebuilding process seriously impact income losses too. And holdups are likely when structural changes must meet modified building code, new plans must be drawn and submitted, and permits approved. Even rebuilding without design changes can be slow due to a lack of materials and labor following a catastrophe.

Income-loss coverage for your facility should be set accordingly. Policy limits with respect to time insured for business interruption, dollar limitations on income loss, or limits to offset delays because of ordinance or law can usually be increased if deemed necessary.

If youre in the dark about general construction cost increases or changing building codes, now is a good time to talk to your friendly contractor. Then, use that knowledge by speaking with your insurance agent and assuring your facility is appropriately covered. 

Scott Lancaster started his insurance career in 1976 as a licensed insurance agent and broker in California. He is now the regulatory compliance officer for Deans & Homer, where he was hired as a commercial lines property and casualty underwriter in 1985 and has worked in the self-storage division since 1993. Deans & Homer has provided insurance products designed to respond to the unique risks of the self-storage industry since 1974. For more information, call 800.847.9999; visit www.self-storageinsurance.com.