As the Marshall Fire in the Boulder area revealed, it’s essential to regularly update your property insurance for fire and other hazards. 

Of course, this wasn’t the first wildfire to demonstrate the need to purchase and regularly update insurance for your business, rental properties and home. 

Think back to the East Troublesome Fire in 2020 and Hayman Fire in the early 2000s. Many of the businesses and homes destroyed in the East Troublesome and Hayman fires were older. After the mortgages were paid, owners dropped fire and hazard coverages and kept liability insurance only. Other businesses and homes were uninsured.

In the Marshall Fire, even the newest properties were almost immediately underinsured because of the rapidly increasing costs of building and labor.

What does it mean to be underinsured? How does this happen, especially when a business or home is nearly new and insurance companies asked dozens of valuation questions before issuing policies?

A building should be insured for at least 80 percent of what it would cost to rebuild from the ground up. Rebuilding costs don’t include the value of the land or foundation unless the foundation was destroyed. In the recent past, the resale price of a building with associated property was usually significantly more than what it would cost to rebuild the structure. As a result, the insured value was less than the resale price. 

According to a story by Noelle Phillips in the Denver Post — https://www.denverpost.com/2022/02/18/colorado-marshall-fire-insurance-underinsured — the underinsurance problem is exacerbated by how expensive new home construction has become in Colorado during the COVID-19 pandemic with supply chain backups, labor shortages and rising inflation.

Since the cost of the components of constructing a building have skyrocketed, a building that was adequately insured even a month or two ago might now be underinsured. As soon as the insured value is less than 80 percent of the rebuilding cost, your building is almost certainly underinsured.

If you’re underinsured, the insurance company will look at what percentage of the actual rebuild cost your insurance covers. Assume you’re insured for 60 percent of what it would cost to rebuild. If the rebuild cost is $600,000 and your building is a total loss, the insurance company will usually only cover 60 percent of that amount or $360,000. If you suffer a partial loss, say $100,000, the insurance company will usually only cover 60 percent of that amount as well. 

If the building in the preceding example had a resale estimate of $450,000 (less than the rebuild cost), you might think you’re properly insured since 80 percent of $450,000 is $360,000. You’re not. Resale value has nothing to do with rebuild value. Not understanding the difference could cost you.

Another important consideration to ensure your insurance coverage is adequate is to maintain full replacement value for your belongings rather than actual cash value (the depreciated value). Otherwise, you could be rudely surprised to find out the desk that will cost $1,000 to replace is only worth $100 for insurance replacement purposes. Make sure you have detailed lists of everything inside — with photos and receipts — to ensure you get full replacement for all your stuff. 

If you’re working from a home office, you need to have a separate business policy for business property, even if your employer extends its coverage to offsite property.

What are the risks with being uninsured?

Many people make the mistake of dropping insurance coverage once the mortgage is paid off. As so many people discovered after Colorado wildfires, a building can be destroyed in an area where fires aren’t likely to occur. Without insurance coverage, you’re on your own for the cost of demolition, securing the site rebuilding and refurnishing.

The bottom line: Resale value has nothing to do with rebuild value. The replacement value of a building isn’t what its estimated resale value is, but what it would cost to reconstruct the same building.