Evaluating Commercial Replacement Cost Estimates: Beyond the Numbers Finale

This is the last in a series of guest posts from our friend Michael Gay. Documentation May Become “Exhibit A” For agents, one of the most important risk management tools is documentation. In my expert witness work, the agency file can become critically important. Years after a policy was written, that file may be the best evidence of how a building limit was established. A good file should make it possible to determine where the building information came from, who supplied it, what valuation methodology was used, what estimate was generated, what recommendations were made, and what decisions the insured made. Retain the complete replacement cost estimate, not merely the final number. If information came from the insured, document it. If the agent recommended a higher limit and the insured declined it, document the recommendation and the insured’s decision. If the insurer conducted an inspection or produced its own valuation, retain that information. Documentation does not correct an inadequate valuation. But years later, it may establish whether the agent followed a reasonable process and what information was actually available when the coverage decision was made. Treat Valuation as a Process, Not a Number The most important lesson is that commercial replacement cost estimating should not be viewed as a one-time calculation. A replacement cost estimate that was reasonable in 2020 may be materially inadequate today even if absolutely nothing about the building has changed. Turner Construction’s Building Cost Index indicates that U.S. nonresidential building costs rose approximately 32% from the 2020 annual average through the second quarter of 2026. Applying that index movement for illustrative purposes, a $5 million 2020 valuation would equate to approximately $6.6 million by the second quarter of 2026 based solely on construction-cost escalation. (Source: Turner Construction Company, Building Cost Index, 2020 annual average through Q2 2026.) A credible valuation begins with accurate information about the property, uses an appropriate estimating methodology, reflects current construction costs, and is periodically revisited as the building and economic conditions change. Agents should be particularly cautious about simply carrying the same building limit forward year after year with only an automatic inflation adjustment. Inflation protection is useful, but it cannot correct a valuation that was materially wrong at inception or account for building changes that were never reported. When a commercial building is substantially underinsured, the analysis should therefore go beyond asking, “What did the replacement cost estimator say?” The better questions are: What information went into the estimate? Where did it come from? Was it accurate? Were obvious discrepancies investigated? Was the estimate periodically updated? What recommendations did the agent make to the insured? And how was the resulting valuation translated into the limit purchased? Those questions matter before the loss. After the loss, they may determine whether an underinsurance problem remains a difficult coverage issue or becomes a multimillion-dollar dispute involving the insured, insurer, agent, and the agent’s E&O carrier. A replacement cost estimator can produce a number to the dollar. The real question is whether anyone can explain and defend how that number was produced. After a multimillion-dollar property loss is a poor time to discover that no one can. When the Valuation Is Beyond Your Expertise Some readers may be thinking, “This sounds like more work than I can reasonably do. I’m an insurance agent, not a contractor, engineer, or building appraiser.” That is a reasonable concern. Evaluating a replacement cost estimate does not require an agent to become a construction expert. It does require recognizing when the available information, estimating tool, or agent’s own experience is insufficient to support a reliable valuation. For a relatively straightforward building, accurate information and a properly used estimator may provide a reasonable basis for selecting limits. A complex facility, specialized construction, missing building records, or a substantial unexplained difference between estimates may call for a qualified professional experienced in estimating reconstruction costs for insurance purposes. Explain that need to the insured. Recommend an appropriate valuation, document the recommendation and the insured’s response, and work with the insurer to understand what information it requires. If the insured declines, document the unresolved concerns and avoid presenting an uncertain estimate as a verified replacement cost. As I discussed in my previous “Stay in Your Lane” articles, recognizing the limits of your competence is part of professional judgment. (See: Stay in Your Lane – Part 1 and Stay in Your Lane – Part 2). Seeking qualified help, partnering with an experienced specialist, or referring an account can be the appropriate response when you cannot handle it responsibly. Time and expertise have costs. Those costs should be considered when deciding whether your agency is equipped to serve an account. A substantial premium does not make an unfamiliar exposure easier to understand. You do not have to know how to rebuild every building you insure. You should recognize when you need someone who does—and act before the loss makes that need obvious. About the Author Michael Gay, CPCU, AAI, AAI-M, AINS, AIS, ARM, CRIS, RMPE, is an insurance consultant, educator, author, and expert witness with more than 40 years of experience in the property and casualty insurance industry. His career has included executive leadership at insurance carriers, managing general agencies and retail agencies, as well as agency ownership. He co-authored with Patrick Wraight Risk-Proof Your Business: The Complete Guide to Smart Insurance Choices—Expert Insights for Navigating and Mitigating Business Risks (Wells Media Group, 2024). He is the founder of Michael Gay Consulting, LLC. Topics Commercial Lines