The whole point of any insurance deal is to shift the risk from your own pocket to the pockets of all the other insured. Spreading the costs among a big pool of other businesses reduces your own payments. But the main issue is always going to be the way in which the insurer values the loss if and when you make a claim. Although it’s an obvious statement that you do not want your own business to pay for replacing property used in the business, exactly how do you ensure the premium is less than the cost of replacement? So how the lost property replacement is calculated?
Property replacement formulas used by business insurance companies
The first factor for this is a fair market value. The formula is the price paid less the depreciation. For instance, your business may use a truck for delivery purposes. For tax purposes, you will be allowed to write down a percentage of the truck’s value every year. So, if the vehicle is seriously damaged, the actual cash value would be the book value measured against the average prices in the secondhand market for vehicles of a similar age. This reflects a basic truth that the standard policy will not buy new for old. As a general rule, you cannot make a profit out of the insurance policy. If you got a new vehicle for one that was three-years old, you would be benefitting unfairly, particularly if the manufacturer’s price had increased over the three years.
Then comes a simple paying out the cost of replacing the property and this is a better deal potentially. As an example, take the loss of stock whether as raw materials or for sale. Suppose you have a store of clay for making pottery. You want to be in no worse position so want the insurer to replace the volume of clay lost even though the price may have risen in the local market. It would be the same for any manufactured stock held for sale. Whether you manufactured it or bought it in, you need to replace it. Often this type of stock is circulating and will not be subject to depreciation so paying the extra premium rate for replacement may be better value.
Finally, the third factor is an assessment of whether there has been any other loss flowing from the loss of the individual assets in case the business has suffered other losses while the property loss. Consequential losses are always a difficult area and this is something you need to check with your business insurances provider. Say, for example, you are in a supply chain and subject to penalties if the parts you manufacture are not delivered on time. The next batch is destroyed in a fire and the penalty is applied. Now your loss is the cost of replacement plus the amount of the penalty. A business covrage is all about balancing the cost of the premium against the security you buy. Make sure you understand how the insurers value loss before you sign up for your next policy.