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The article in brief:

• Companies are reassessing their commercial insurance needs due to high inflation and increased asset prices.
• The uneven effects of inflation across industries highlight the importance of evaluating insured real and personal property values relative to replacement costs.
• Obtaining a third-party valuation expert’s replacement cost analysis can support and ensure adequate coverage, whether due to good governance or an upcoming M&A transaction.

Whether you’re a large multi-national company or a small local business, protecting your assets from a minor setback or a major catastrophic loss is critical to the long-term success of your business.

In recent months, companies of all sizes have been recalibrating their commercial insurance needs based on high inflation and resulting higher asset prices. Inflation has been softening slightly, but it remains well above long-term trends. The impact of inflation and higher prices is now “baked into” asset costs, and, as a result, many companies are looking closely at replacement costs for insurance purposes. Increasingly, VRC’s longstanding clients and prospects are asking whether the real and personal property they invest in heavily may be at risk and underinsured in a time when capital asset costs have increased by as much as 40% in the last three years.

The Uneven Effects of Inflation

The U.S. Bureau of Labor Statistics trends show material inflation across all industries, with a significant jump in costs—mainly for raw materials and labor—since early in the pandemic.

We have found the impact of inflation on underlying asset costs differs from industry to industry. Indices from Marshall & Swift Valuation Service suggest some industries, such as chemical, glass, and petroleum, have increased the most over the past three years. The magnitude of inflation and, even more so, the range of variability across various industries highlights the need for current replacement cost appraisals.

Regardless of industry, now is an ideal time to evaluate whether the insured value of your property is reasonable relative to its replacement cost.

Common Situations

There are two everyday situations where companies request a valuation for insurance purposes:

1. As a result of high inflation or just good corporate governance, the company may seek an insurable value indication based on the concern that its current coverage may not adequately reflect the current replacement cost. Unfortunately, we have received numerous client requests upon experiencing a loss, whether through natural disasters (fire, flooding, earthquakes, etc.), accidents, or process failures.
2. As part of an M&A transaction, the acquiring company may look to refresh the target company’s insurance and will want to verify that the value of its insurance reasonably reflects the current replacement cost of the property. This is often done with a purchase price allocation exercise, where fixed assets are valued.

VRC’s Approach to Replacement Cost Analysis

Our expertise is in producing accurate and supportable value estimates, accomplished through one of two methods:

1. Direct replacement considers the estimate of replacement based on discussions with management, researching costs gathered from manufacturers and manufacturer’s representatives, and national cost-estimating surveys adjusted for location and economic trends.
2. Indirect replacement considers an indexing approach based on historical cost data that is trended to a current date. The trend factors are derived from statistical information compiled from VRC’s proprietary trend factors, government agencies, and private firms (e.g., Marshall Valuation Service, Compass International, FM Global.)

It is vital to utilize a reputable valuation specialist with expertise in the specific industry and type of assets.

Further, specific policies call for various exclusions or provisions that should be considered within the analysis. For example, the insurance policy may include costs for demolition in the event of a catastrophe and usually excludes land value, underground piping, foundations, and sometimes various site improvements.

Our written valuation report includes an itemized detail of your buildings, machinery, and equipment. With this detailed analysis, companies can work with their insurance specialists to ensure adequate coverage.

Summary

Inflation impacts have shifted the playing field for many companies, especially in industries where costs have increased significantly. A vital risk management tool is to take a proactive look at your commercial insurance coverage and the replacement cost of assets covered by these policies. Taking your eye off the ball could potentially result in catastrophic consequences.