When an individual or business buys property insurance, the primary concern is normally the replacement of the building if a fire completely destroys it. However, in many losses, a portion of the building escapes damage or machinery and equipment may be salvageable. In these situations, the policyholder and the insurance company must decide whether to repair the property or replace it altogether. The policy ordinarily states that the company will do whichever costs less. However, the answer to which costs less can become a gray area, complicated by several factors.
In some situations, the policyholder may want the property replaced, rather than repaired. For example, the business may want to replace equipment because repairing it would void the warranty. It may want to replace damaged products because buyers will be reluctant to purchase refurbished ones. The business may also fear an increased likelihood of product liability claims from these goods.
In some instances, there may be doubt as to whether repair will be less expensive than replacement. Old buildings, especially dwellings that have been converted to commercial use, may have been constructed with materials no longer in common use, such as plaster and lathe. Also, some types of machinery and equipment may be less expensive to replace because the price of a new unit has decreased, but the new unit may lack some features that the business needs.
Local laws or building codes may also affect the decision. Municipal governments often require a building to be torn down if more than a specified percentage of it needs repair, forcing the owner to replace it.
The age of the property or its components is also a factor. In the case of computer equipment, which tends to decline in price over time, replacement may well be the less expensive option. The answer may not be as clear for other types of property, such as construction equipment (assuming the policy covers such equipment for replacement cost.) A 15 year-old bulldozer that suffered damage in a rollover may be repairable, but it may also be near the end of its useful life. The same may be true of the electrical system in a 30 year-old building; perhaps only 20 percent of the wiring suffered damage, but it might be less expensive (and better loss prevention) to update the entire system.
Finally, buildings constructed decades ago may have architectural features, such as gables, atriums, or balconies, which are not important to the owners. Replacing the building with one lacking these features may cost less than repair.
If the policy provides Business Income or Extra Expense coverage, the company must weigh the impact of the repair/replace decision on them. For example, assume that fire has destroyed 60 percent of a building, forcing the business to shut down. Replacing the building with a similar one in a location ten miles away will cost 50 percent more than repairs would, but the business could resume operations there in three months, as opposed to a six-month shutdown if the building is repaired. When the company considers all of the applicable coverages, it may well find that replacement is the less expensive option.
Ultimately, the policyholder must negotiate the repair/replace issue with the insurance company. A business owner who is unhappy with the company’s proposed settlement should follow the steps listed in the policy for contesting it. The firm’s insurance agent can be a valuable ally at claim time, as she is familiar with the process and may be able to intervene on the firm’s behalf. Working together, all parties should be able to decide on an approach that quickly gets the business back to normal.