Fire Insurance for Your Business

Insure Your Business Against Fire Damage

Factory burning at night in Baltimore
Image courtesy of [Glowimages] / Getty Images.

Most businesses that own property need insurance to protect themselves against the risks of fire. This article will explain why fire insurance is essential and how it is normally provided.

Need for Coverage

A fire can devastate a business. Flames, smoke and water used to extinguish the fire can severely damage buildings and their contents. If the business has no fire insurance, it may lack the funds to rebuild or repair the damaged property.

The company may be forced to cease operations. Thus, fire insurance can be essential for the survival of a business.

Until the mid-twentieth century, businesses protected themselves against fire damage to buildings and personal property by purchasing a fire insurance policy. Nowadays, most businesses purchase a commercial property policy or a businessowners policy (BOP), a type of package policy. These policies cover damage caused by fire and many other perils.

Valuation

As a small business owner, you may think that insuring your property for less than its value is a good way to save money on property insurance. This is a fallacy. For one thing, your policy won't cover the full cost of repairing or replacing your property if it 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 limit of insurance that is a specified percentage of your property's value.

For example, suppose your property policy includes a coinsurance requirement of 80%. 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. 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.

ACV Versus Replacement Cost

Many property policies pay losses based on the actual cash value (ACV) of the damaged property rather than its replacement cost. Actual cash value is typically calculated by subtracting depreciation from the replacement cost. For example, suppose that your building will cost $3 million to replace. The building 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 destroyed. You will need to come up with an additional $500,000 to rebuild the structure. 

Personal property, such as machinery, equipment, and furniture, can also be costly to replace. Business owners can protect themselves against large out-of-pocket expenses by insuring these items 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.

Specialized Coverage

Property policies generally exclude or afford limited coverage for certain types of property. Examples are money and securities, valuable papers, jewelry, and aircraft. Other types of property, such as computers and refrigeration equipment, are prone to damage by perils that are excluded under the policy. Such property can often be covered under a separate form or endorsement attached to the policy.

Business Income Coverage

When its property is severely damaged, a business may be forced to reduce its operations or to shut down altogether. A full or partial shutdown may cause the business to sustain an income loss.

If the business keeps operating, it may incur extra expenses. Income losses and extra expenses are not covered by fire insurance. To protect itself, the business can purchase business income coverage.

Building Codes

Many businesses operate in older buildings that do not meet current building codes. Building laws vary from state to state and city to city. Generally, building owners don't have to upgrade their buildings to meet existing codes until those buildings are reconstructed or refurbished. Upgrading a building to meet current codes 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 a few tips regarding your fire insurance policy.

  • Review your policy annually to ensure that it includes all of your buildings and all of your locations. Make sure the addresses listed in the policy 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 employees so that they know what to do in the event of a fire. Your insurer may provide a discount for an active fire prevention program.

Article edited by Marianne Bonner