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With inflation reaching its highest point in 40 years and subsequent steep interest rate hikes, the real estate investment insurance landscape has changed significantly this year. For one thing, insurance costs are rising.
Two Main Factors Contributing to Rising Insurance Rates
Since the onset of the pandemic in 2020, businesses have been experiencing the sharp pangs of a hard insurance market. Hard markets are characterized by higher premiums, more restrictive terms, decreased capacity and enthusiasm for underwriting, and less competition for new business among insurance companies.
Today, real estate investors are getting hit hard at renewal time with rate increases, with some seeing premiums rise as much as 30%.
The second factor contributing to rising rates is that insurance carriers are pressing real estate investors to increase their valuation of properties per square foot. Increasing the per-square-foot property value also increases the property’s total insured value (TIV). In most cases, higher overall TIV means higher insurance costs.
Because insurance premiums are calculated based on the property’s value, some real estate investors have tried to save on their insurance premiums by under-reporting the TIV of the property. While this approach can save some of them money on their premium in the short term, it goes against their long-term best interests.
The Cost of Undervaluing TIV
Inaccurate or artificially devalued TIV is a common source of property claim litigation. Undervaluing TIV also means you risk getting paid out based on actual cash value (ACV) instead of the replacement cost value (RCV) and you could also face a co-insurance cost penalty.
While insuring only the amount you’ve invested in your real estate property may seem appealing, it can result in only having coverage for partial losses subject to a co-insurance penalty.
What’s the difference between ACV and RCV?
ACV is how much money you would need to repair or entirely replace your investment property. ACV depends largely on considerations such as inflation and depreciation. Basically, ACV is what the property would be worth on the market if you were to go out and sell it today.
The advantage to insuring based on ACV is that there is usually a cheaper premium, so you tend to pay less over the life of their policy.
The downside is that if you experience a loss, the actual cash value might not be enough to cover the total cost to repair or replace your property.
RCV is the money needed to repair or replace your investment property. RCV replaces the entire value of the property without a deduction for depreciation.
The advantage to insuring based on RCV is the payout in a loss covers the entire cost of the property. Using RCV, premiums will be higher over the policy’s life.
A Brief Example
Let’s say you have an $800,000 property. You’ve owned the property for one year and the depreciation rate is 3.5%. You experience a total loss that was covered by your insurance policy.
- An ACV policy would pay out $772,000 for your property
- An RCV policy would pay the full $800,000 for your property
Conclusion
Although the insurance marketplace is hardening across all business sectors, coverage prices vary from company to company, so it’s in your best interest to shop around.
When shopping around, be sure to compare prices and services of several companies so you can get a feel for the types of services they offer.
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