Reconstruction Costs: A Tricky Variable in Commercial Property Insurance

However, the cost of commodities and labor are not the only factors. Another large cost increase for property risk comes from the reinsurance market. Insurance companies purchase reinsurance to increase capacity and protect against catastrophic losses like large natural events. Convective storm activity, hurricanes, tornados, flooding, and wildland fires are examples of natural perils that can become catastrophic losses to insurance companies. According to Swiss RE, in 2023 natural catastrophes resulted in economic losses of $280 billion. Of these, $108 billion (40 percent) were covered by insurance, above the previous ten-year average of $89 billion. Increased costs to the primary insurance companies who purchase reinsurance are contemplated in the rate, and that will subsequently influence the insured’s premiums.

Valuation Tools

The insurance industry uses certain programs and applications to help estimate reconstruction costs. For ninety years, Marshall & Swift has been the gold standard for providing building costs to multiple industries. Started in 1930, the Marshall & Swift Valuation Service was compiled and published by Marshall & Swift-Boeckh and provided residential and commercial analytics solutions and business management services. The cost data presented was “based on years of valuation experience, thousands of appraisals, and continual analysis of the costs of new buildings.”

Marshall & Swift was acquired by CoreLogic in 2014. CoreLogic is global property information, analytics, and data-enabled services provider. The analytics CoreLogic uses to calculate a reconstruction cost are proprietary, but the company’s combined data includes public and contributory sources with more than 3.3 billion records spanning more than forty years providing detailed coverage of property, mortgages, hazard risk, and related performance information.

Subscribers such as insurance companies enter property information such as occupancy, size, construction type, finishes, and location. Then the program formulates a valuation in real-time for the total cost for reconstruction of that building. It is merely a snapshot in time, but the program is continually evaluating variables for construction costs. Depending on the CoreLogic product that is purchased, costs are updated monthly, quarterly, or annually.

While the program is utilized nationwide, it has had continual challenges in accurately depicting reconstruction costs in Alaska. The state of Alaska has unique challenges that anyone who has been here can appreciate. Commodity delivery logistics, lack of an extensive road system, remote locations, and a limited number of contractors and workers are not contemplated accurately in the CoreLogic cost analysis, leaving the program’s estimates undervalued. Many property claims have been reported over the years where the total loss incurred per square foot is much higher than the estimated reconstruction cost using the commercial cost estimator, sometimes by 40 percent.

Local Multiplier

Insurance companies know that these values are not accurate and have had to use different means to bring the values up to accurate levels. While some users may use construction quality to increase the price per square foot, the user adjustment section in the program allows for a “local multiplier” to be supplied. This is the most accurate variable to change, because construction quality is subjective.

To create an accurate local multiplier, insurance risk managers and loss control consultants are likely to analyze property losses by location to see what the reconstruction cost was at the time of the loss. This involves working closely with the insurance claims team to look at the facts and the property details. This is the most accurate way to determine actual costs to build because many losses are partial losses and are more expensive than building from scratch. However, in an area where property losses for the insurance company have not occurred, speaking with local contractors and assessing their estimates for construction can also work.

The caveat is that, in large areas of Alaska, many contractors are already booked for a year or more in advance. Therefore, estimates quoted at the time of inquiry may be lower than the estimates provided at the time of a property loss, which is fortuitous and never planned. In other cases, the local contractors are not even available due to previously scheduled work, and out-of-location companies must be brought in to complete the work—often at a much higher rate. Add to that jurisdictional building permit requirements and multiple municipal and state inspections, and costs can escalate quickly.

Moving materials in Alaska is difficult. While barging products in and around parts of Alaska can happen year-round, many communities have frozen riverways and ports during the winter months. This creates a need to have materials flown in or transported over snow and ice, often at a very high cost. If an airport in a village is not able to accommodate larger aircraft due to runway length, other means of delivery may have to be arranged. Sometimes the reconstruction will have to wait until summer.

Even properties along the road system in Alaska can be expensive. Some locations like Deadhorse or Tok are quite the distance from the origin of the materials and likely require overnight travel by the truck driver, which increases delivery costs. In addition, housing employees for the entire length of the build in these remote areas also comes with a high price tag, adding to the total cost of the build.

Before Things Go Bump

The best bet to avoid coming up short on reconstruction costs for your company’s commercial property insurance is to work closely with your insurance broker. The brokers work closely with the commercial insurance carriers and will be able to assist in ensuring that the buildings are insured to value. Do not wait until a month before your insurance renewal to make it happen. Now is the best time to start this process.

While most property owners proactively protect their buildings against loss, things do go bump in the night. When that happens, it is best to have it buttoned-up. Property losses can be devastating, and the last thing one wants to think about after a loss is whether it is adequately insured.