Fire Insurance for Your Business

Insure Your Business Against Fire Damage

Bright red fire hydrant
Image courtesy of [Claro Fausto Cortes / EyeEm] / Getty Images.

Most businesses that own property need insurance to protect themselves against damage caused by fire. Fire insurance for businesses is widely available. Many insurers that sell business insurance offer this coverage.

Need for Coverage

Fire is a major cause of property damage. In 2015, 1,345,000 fires were reported in the United States according to the National Fire Protection Association. These fires killed 3,280 people (excluding firefighters) and caused about $14.3 billion in property damage.

Most of the fire-related deaths occurred in residential structures, which include one-or-two-family homes, apartment buildings, hotels, and motels.

A fire can devastate a small business. Fires generate flames, smoke, and heat, any of which can damage buildings and their contents. Water, foam and other materials used by firefighters to extinguish a blaze can also damage property. A business that has no fire insurance will have to pay for repairs or reconstruction out of pocket. It may also have to reimburse the fire department for the cost of extinguishing a fire if the local fire department charges for its services.

If a company lacks the funds to pay these costs, it may be forced to cease operations. By purchasing adequate fire insurance, a company can significantly improve its chances of surviving a large fire loss.

Hostile Versus Friendly Fire

In the insurance industry, fires are classified as friendly or hostile.

A friendly fire is one that is set on purpose and that remains in the place intended, such as a fireplace or stove. A fire becomes hostile when it escapes from its intended location. For example, flames from a gas burner ignite grease spilled on a restaurant stove. The fire travels up a wall and burns the roof of the building.

Property insurance covers damage caused by hostile fires.

Commercial Property Policies

Until the mid-twentieth century, businesses protected themselves against fire damage to buildings and personal property by purchasing a fire insurance policy. In the 1960s, insurers began offering commercial multiperil policies. These covered damage caused by a variety of perils, such as hail and windstorm, as well as fire. Multiperil policies were phased out in the 1980s when ISO introduced new forms written in simplified language. These forms are still in use today. They include the commercial property policy and the businessowners policy (BOP), a type of package policy.

ACV Versus Replacement Cost

Many property policies pay losses based on the actual cash value (ACV) of the damaged property. Actual cash value is typically calculated by subtracting a property's accumulated depreciation from its replacement cost.

For example, suppose that your building is insured for its actual cash value. The building will cost $3 million to replace. It is ten years old and has depreciated by $500,000. The building's actual cash value is $2.5 million. If you insure the building based on its ACV, your insurer will not pay more than $2.5 million if the building is completely destroyed.

You will need to come up with an additional $500,000 to rebuild the structure. 

Business personal property includes items like machinery, equipment, and office furniture. Such property can be costly to replace. You can protect your business against a large out-of-pocket expense by insuring your personal property on a replacement cost basis.

Replacement cost coverage pays the cost of repairing damaged property or replacing it with similar property. This coverage costs more than coverage based on actual cash value.

Don't Underinsure Your Property!

Like many business owners, you may think your insurance premiums are too high. Perhaps you've considered saving money on property insurance by insuring your property for less than its full value. This is a bad idea!

For one thing, your policy won't cover the entire cost of repairing or replacing property that is destroyed by a fire or other peril.

Secondly, most property policies contain either an agreed value clause or a coinsurance clause. These clauses impose a penalty if you fail to purchase a minimum limit of insurance relative to the value of your property when the loss occurs.

For example, suppose your property policy includes a coinsurance requirement of 80 percent. Assume that your policy covers losses on a replacement cost basis. If the replacement cost of your building is $2 million, you must insure your building for at least $1.6 million (80 percent of $2 million). If a loss occurs and you have failed to purchase the required amount of insurance, your insurer will not pay the full amount of the loss. You will be stuck paying a portion of it yourself.

You can avoid penalties for underinsurance by taking these steps:

  • Insure your property for 100% of its value.
  • Hire an experienced appraiser to reassess the value of your property every year or so. The best time to do this is before your policy's renewal date.
  • Don't insure your property based on property tax evaluations or estimates provided by your insurance agent.

Excluded Property

Property policies contain exclusions and limitations that apply to certain types of property. For example, most policies exclude loss or damage to land, building foundations, and money and securities. Many provide a small amount of coverage for valuable papers, jewelry, and outdoor plants.

Property policies also exclude perils that can cause damage to certain types of property. Examples are electrical disturbances, which can damage computers and data, and mechanical breakdown, which can damage refrigeration equipment. Some of these perils can be covered under a separate form or endorsement attached to the policy.

Business Income Coverage

When its property has been severely damaged, a company may be forced to reduce its operations or to shut down its business altogether. A full or partial shutdown may cause the business to lose income or incur extra expenses. Income losses and extra expenses are not covered by basic fire insurance. To protect itself, the business can purchase business income and extra expense coverages.

Building Codes

Many businesses operate in older structures that do not meet current building codes. Building laws vary from state to state and city to city. Generally, existing buildings need not meet current codes unless they are refurbished or rebuilt. If a building is severely damaged by a fire or other peril and is repaired or reconstructed, the structure may be subject to current codes. The required upgrades can be costly. The extra costs imposed by building codes aren't covered under a typical property policy. Coverage for such costs is available under building ordinance coverage.

Finally

Here are some tips for maintaining your fire insurance policy.

  • Review your policy annually. Make sure it includes all of your buildings and all of your locations. Check the addresses listed in the policy ensure they are accurate.
  • If you own multiple buildings, consider insuring them under a single policy with a blanket limit. One policy will be cheaper than several individual policies. 
  • Draft and maintain a fire prevention plan. Train your workers on the steps they should take if a fire occurs. Your insurer may provide a discount for an active fire prevention program.

Article edited by Marianne Bonner