Valuation and appraisals
What is the typical "Replacement Cost" valuation basis for real property and personal property?
Real property (buildings): On buildings and structures — replacement cost new with materials of like kind and quality.
Personal property: On machinery, equipment, furniture, fixtures and improvements and betterments — replacement cost new with materials of like kind and quality.
"Replacement cost new" should include the cost to ship replacement equipment/parts to your facility, which can be a high cost for large, heavy machinery and/or if it's coming from overseas. The cost of any professional installation and testing required should also be included.
Valuation adequacy and claims inflation
The topic of "valuation adequacy" has been simmering below the surface for a number of years, but went largely unaddressed during the soft market cycle for 10 years prior to 2017. While some insured's diligently applied the most recent indexing factors and/or obtained appraisals on a rotational basis in an effort to maintain current "replacement cost" valuation, many ignored the issue and recycled old valuations across multiple renewals, which got them further away from adequate valuation each year.
FM Global published their biannual cost index report at the beginning of the year, showing an overall average annual inflation index (January 2022 v January 2021) of 18% for real property and 7% for machinery and equipment, as well as 30% for some specialty engineering equipment. Various qualified, third-party valuation and appraisal firms (Marshall & Swift, Duff & Phelps, CBIZ, Stout, Gallagher Bassett and others) have also released reports during the past several months that support similar levels of inflation to the index factors offered by FM Global.
Post-pandemic inflation is driving reconstruction costs and increasing claims due to high consumer goods demand and supply chain disruption. The increase in cost and availability of construction materials is causing insurer's claims costs to soar and increase industry focus on valuation. "Valuation adequacy" has become the #1 focus for most insurers in 2022.
In addition to the cost and availability of materials, increased labor costs and sparse contractor availability are also driving higher overall replacement cost of facilities. Insurers have been experiencing firsthand a widening in the gap between the actual cost to rebuild in the claims they are paying, versus the values reported by many Insureds on their statement of values (SOV).
Insureds should discuss purchasing replacement cost appraisals with their brokers, to ensure valuation adequacy for both buildings, and machinery and equipment. For large facilities, the cost to do so may be less than applying a standard 18% inflation factor to insured's property values, at the same premium rate. For many manufacturing clients, the inadequacy of machinery and equipment values is often equal to, if not more understated than, the building values.