It’s been a rollercoaster ride for construction material costs, giving commercial building owners good reason to make sure their property insurance policy is still on track.
This past May, lumber prices hit record highs as home renovations and repairs flourished throughout the pandemic and supplies were squeezed. According to Statistics Canada, softwood lumber prices rose by 118.9% in Canada between March 31, 2020 and March 21, 2021.1
By July, lumber prices came crashing down, however, industry experts predict they will stay above pre-pandemic levels for the next five to 10 years.2
Meanwhile, prices for iron and steel products were 50.9% higher year-over-year in July, driven by strong demand from China.3
What do construction costs have to do with property insurance? “When the cost of materials such as lumber and steel go up, the replacement costs naturally go up,” says Bob Lawlor, Senior Casualty Specialist – Atlantic Region, at Sovereign Insurance. “And so, policyholders need to make sure they are properly insured based on today’s replacement costs and the property’s true value.”
With increases and fluctuations in the cost of materials, commercial building owners may be at risk of being underinsured. If the price to rebuild or repair damage or loss is more than a policyholder is insured for, they have to pay the difference out of pocket.
The reason has to do with an often misunderstood term for policyholders: co-insurance. A co-insurance clause requires a building to be insured for a percentage of its replacement value. The clause makes sure policyholders insure their property to a specified percentage of the property’s value in order to receive full compensation in the event of loss or damage.
Generally, if a commercial building owner is insured for replacement costs, they are required to have at least 90% of the value of the property insured. So, for example, if they have a $1 million building, they need at least $900,000 in coverage to have it replaced. If they have the building insured for $500,000, a penalty clause would be invoked since they chose to retain part of the risk themselves. (The formula is basically dividing the amount of insurance purchased by the amount they should have to satisfy co-insurance, which is then multiplied by the amount of the loss.)
Even though lumber prices have come back down to earth, it’s believed that a significant amount of buildings were under-insured before COVID-19 happened. In fact, one report suggests that on average, 70% of commercial properties in Canada are under-insured by 40%.4
This is a good opportunity for any commercial building owner to review their coverage.
“Brokers and insurance companies have the same goal: we want to provide our clients with proper insurance,” says Bob. “It’s important that buildings have the proper values documented on their policies, so that in the event of a loss or damage, the client is covered properly as the costs can be significant.”
Ultimately, the onus rests on the insured to make sure the proper value of their building is documented in their policy. Bob suggests that if there is any doubt, owners should get a commercial building appraisal or have a contractor assess the property, taking into consideration replacement costs.
For their part, brokers can be proactive and raise the issue with their clients. “If they haven’t had those conversations yet, and a client has a loss today, they could be underinsured,” says Bob. “My advice would be don’t wait until the policy is up for renewal. Be in contact with clients now to make sure they’re aware of the issue and that their building values are up to date. Then, the client can determine a course of action on their coverage if necessary.”
The Western Producer, “StatsCan data confirms stratospheric increase in lumber costs,” May 6, 2021
CTV News, “Lumber prices have plunged, but experts don’t expect them to back to pre-pandemic levels,” July 30, 2021
Kitco, “Canadian steel products prices up 51% year-over-year in July on strong demand from China,” Aug. 27, 2021
4 Nova Scotia Insurance Women’s Association, “Underinsurance in Atlantic Canada,” May 16, 2016