Fire Insurance for Your Business

Commercial Property Policies Have Replaced Fire Policies

Bright red fire hydrant

Fire is one of the most common causes of damage to business-owned property. Fire damage can be costly to repair so many businesses protect themselves against potential losses by buying insurance. Fortunately, fire insurance is widely available. Many insurers that sell business insurance offer fire insurance as part of a commercial property policy.

In the insurance industry, fires are classified as friendly or hostile. A friendly fire is one that is set on purpose and that remains in the place intended, such as a fireplace or stove. A hostile fire is one that is unintended or uncontrollable. Fire insurance protects businesses from damage caused by hostile fires.

Need for Coverage

In 2017, 499,000 structure fires occurred in the U.S. according to the National Fire Protection Association. A majority (72%) of the structures were homes while the remainder were commercial, institutional or public buildings. The fires caused approximately $10.7 billion in property damage.

Fires can be very destructive because they generate flames, smoke, and heat, any of which can damage buildings and their contents. Fire-fighting materials like water, foams, and powders can also cause property damage. Most property insurance covers damage caused by fire or fire suppression materials. Many policies include some coverage for fees charged by a fire department for fire-fighting services.

A business that has no fire insurance will have to pay for repairs and fire department service fees out of pocket. If the business lacks the financial resources to pay these costs, it may be forced to cease operations. By purchasing adequate fire insurance, a company can significantly improve its chances of surviving a large fire loss.

Commercial Property Policies

Until the mid-twentieth century, businesses protected themselves against fire damage to company-owned property by purchasing a fire insurance policy. By the 1970s, fire policies had been replaced with commercial multiperil policies. These policies covered damage caused by a variety of perils, not just fire. Multiperil policies were phased out in the 1980s when ISO introduced new forms written in simplified language. These includes the commercial property policy and the business owners policy (BOP), which are still in use today.

Property policies don't cover all types of property. For example, most exclude land, vehicles, and aircraft. Policies also exclude perils, like flood and earthquake, which can cause catastrophic losses. They also exclude perils to which certain types of property are highly vulnerable. Examples are electrical disturbances, which can damage computers and data, and mechanical breakdown, which can damage machinery and appliances. Some of these perils can be covered for an additional premium under a separate form or endorsement.

ACV Versus Replacement Cost

Many property policies pay losses based on the actual cash value (ACV) of the damaged property. Actual cash value is typically calculated by subtracting a property's accumulated depreciation from its replacement cost.

For example, suppose you own a 10-year-old warehouse that will cost $3 million to replace and has depreciated by $500,000. The building's actual cash value is $2.5 million. If the building is insured for its ACV and it is completely destroyed, your insurer will not pay more than $2.5 million. To replace the building, you will need to come up with the remaining $500,000 yourself. 

Replacement cost coverage pays the cost of repairing damaged property or replacing it with similar property. This coverage costs more than coverage based on actual cash value but it can protect your business against large out-of-pocket expenses.

Don't Underinsure Your Property!

Like many business owners, you probably think your insurance premiums are too high. Perhaps you have considered insuring your property for less than its full value to lower your premium. This is a bad idea!

For one thing, your policy won't cover the full cost of repairing or replacing property that is destroyed by a fire or other peril. Secondly, most property policies contain either an agreed value clause or a coinsurance clause. These clauses impose a penalty if insured property sustains a partial loss and you have failed to purchase the required amount of insurance.

For example, suppose you have insured a warehouse under a property policy that includes replacement cost coverage and a coinsurance requirement of 80 percent. If the replacement cost of your building is $2 million, you must insure your building for at least $1.6 million (80 percent of $2 million). If you have insured your building for only $1 million and it sustains $500,000 in damage, your insurer will pay only $312,500 (1 / 1.6 X $500,000) less the deductible.

You can avoid penalties for underinsurance by taking these steps:

  • Insure your property for 100 percent of its value
  • Hire an experienced appraiser to reassess the value of your property every year or so.
  • Don't insure your property based on property tax evaluations or estimates provided by your insurance agent.

Building Codes

Many businesses operate in older structures that do not meet current building codes. Building laws vary from state to state and city to city. Generally, existing buildings need not meet current codes unless they are refurbished or rebuilt. If a building is severely damaged by a fire or other peril and is repaired or reconstructed, the structure may require costly upgrades to meet current codes. These extra costs aren't covered under a typical property policy. Coverage for such costs is available under building ordinance coverage.

Business Income Coverage

When its property has been severely damaged, a company may be forced to reduce its operations or to shut down its business altogether. A full or partial shutdown may cause the business to lose income or incur extra expenses. Income losses and extra expenses are not covered by basic fire insurance. To protect itself, the business can purchase business income and extra expense coverages.

Maintaining Your Insurance

Here are some tips for maintaining your fire insurance policy.

  • Review your policy annually to ensure it includes all of your buildings and locations. Make sure the addresses shown in the policy are correct.
  • If you own multiple buildings, consider insuring them under a single policy with a blanket limit. One policy will be cheaper than several individual policies. 
  • Draft and maintain a fire prevention plan. Train your workers on the steps they should take if a fire occurs. Your insurer may provide a discount for an active fire prevention program.

Article edited by Marianne Bonner