The cost of insuring the property against fire

No matter whether you’re a start-up or have been trading for generations, most small businesses operate out of a single industrial unit, office or shop. Thus, all the commercial eggs are in a single building. If anything serious happens to those premises, the whole business will be disrupted and may fail unless repairs can quickly be put in hand or alternative premises are found.

The longer a business stops trading, the more existing customers transfer their loyalties to your competitors. So let’s take a simple example. Suppose you operate a small retail outlet on a lease. You have display space, a stock room, and an office. If there’s a fire or hurricane which levels the building and destroys the stock, can you put the business back together again before all your goodwill disappears? The answer depends on the amount of cover you hold as the leaseholder. This is not a case of replacing the value of the land. You lease the use of the building. The maximum amount you can be required to carry under the terms of the lease is the cost of demolition and complete rebuilding. Then you need to replace all the fixtures and fittings, and restock.

This is not the same as a valuation for a local property tax or to market the property for sale or lease. This is a simple all-in cost for replacement. Think of it this way. On the day of the fire, you call local contractors and ask them, “If you drop everything and come rebuild my premises, how much will you charge?” You’re not in a good bargaining position after a disaster. You do not have the luxury of time to shop around. You need immediate action. That means you will pay for a fast response. Even if you’re the owner of the building, the calculation is exactly the same. The land is still there. It’s only the building that’s lost.

This gives us sobering news. Even though the value of the land may be dropping fast as the housing bubble deflates the economy, the insurance premiums may be rising because the cost of building materials and the labor to build with it may still be rising. You should review the value at which you have your business insurance annually. If you improved the property in any way, or new fire prevention and safety measures are required by local ordinances and building codes, rebuilding costs may be increased. What has happened to the cost of replacing your stock and office furniture over the last year? It’s tempting to cut small business insurance to a percentage of the expected total loss, hoping there will be enough in a “rainy day” fund to cover the difference. Except, there’s no guarantee there will be any surplus cash around when disaster strikes. There’s a simple rule at work here. It’s a false economy to economize on business insurance.

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