HOW TO determine insurance needs for buildings, equipment.

When insuring commercial buildings and equipment, the most important element is setting the proper value or limit of insurance. It may seem like a simple point, but setting improper values is the most common error made on a commercial insurance policy.

The first step of valuation is to determine the replacement cost of the asset. In the case of a building, the replacement cost can be determined by a local contractor. Basically, the cost per square foot, taking into account any upgrades (such as finished basements, electrical equipment etc.) is the method of determining building value. Too many clients mistake replacement cost - defined as the cost of construction of same quality and likeness - with market value. What a business pays for a building, and what the business should insure it for are two different issues.

The valuation method differs for insuring equipment. Generally, what a business owner pays for the equipment is a starting point to. determine the replacement cost. But take note, an accountant's book value of equipment is not an indication of valuing the asset.

The business owner should ask the following questions when determining the value of equipment:

How much will it cost to order new equipment and have it shipped and installed?

In the case of older equipment, what would I replace existing equipment with using today's technology?

Would replacement cost be more or less (for example, when replacing computer equipment)?

All of these questions should be taken into consideration when determining an appropriate limit on your insurance policy. The replacement cost is what you have to pay to get the same quality and likeness as your existing equipment.

The majority of commercial property insurance policies are written on a replacement-cost basis. The alternative is to insure on an actual cash value basis, which basically is a depreciated replacement cost value. Insuring your assets on 'actual cash value' allows you to reduce the limit of insurance to the depreciated value of the asset. This is important for cost-conscious clients because the lower the value, the lower the premium.

A word of caution - it is critical to assess the importance of that asset to your business. If the asset has to be replaced in the event of a claim, insure it on a replacement cost basis. It cannot be emphasised enough how stressful a claims situation can be. Depending on the severity of the loss, you, as a building owner, could be shut down for months...