Forecasters are expecting higher than average storm activityduring the 2006 hurricane season. In addition, fire officials arewarning that the Southwest and Great Plains could see a markedincrease in wildfires this year because of persistent drought andabove-normal temperatures.

Faced with these predictions, business owners throughout theUnited States need to make certain they have adequate property andbusiness interruption insurance to protect their operations. Evenbusinesses in areas not prone to natural disasters should beconcerned about purchasing proper insurance limits. For example, arelatively small fire causing damage to a key production line in amanufacturing plant can result in a significant amount ofdowntime.

Recovery costs could far exceed what was anticipated whencritical machinery and spare parts are not available or slow inarriving. Insurance carriers can work with their commercial clientsto help them determine the true value of their property and thenature and scope of their business interruption exposures. This waythey can secure the appropriate amount of insurance and get theiroperations back online as quickly as possible.

Commercial properties are routinely undervalued. Some businessowners, agents and brokers base a property's value on "book" value,not on the cost to replace the structure, which can be much higher.Book value can mean different things, such as market value atacquisition of the asset, depreciated value, or some form of tradeor wholesale amount.

In addition, as the cost of energy continues to rise, overallexpenses will rise, driving up costs for building materials,transportation and labor. The fact is the actual cost to rebuild orrepair a building or replace equipment can be far greater than theproperty's book value.

Although blanket limits of insurance and policy contractswritten without a coinsurance penalty may allow some losses to beadequately protected against, they are not a substitute foraccurate and adequate valuation.

In situations where valuation is determined to be inadequate, aninsurance carrier may be less willing to write the account orprovide broad insuring terms. In such cases, the policy contractmay be scheduled with specific limits for each location and foreach subject of insurance. Simply speaking, insureds should strivefor insurance value to be certain they can recover 100 percent oftheir loss.

Clients may fail to understand the difference between marketvalue and building replacement cost. An insurer may conclude that$10 million is an adequate replacement cost for a manufacturingplant, but the client may insist the figure is too high consideringthe $6 million sale price for a similar building down thestreet.

Depending on market conditions and availability, it's sometimespossible to buy an existing building for considerably less than thecost to construct a new one. Those business owners who want torebuild at the same location must realize the decision may add totheir costs. The reverse can be true as well. Market value in arising market can outpace the cost to reconstruct, which could leadto overinsuring and potentially paying too much premium.

Consider, too, that on a square-footage basis, a partial losscan be more expensive than replacing an entire building. Often, ina partial loss, there are extra costs for bringing a building up tocode, and these are not necessarily factored in by clients whenestimating the replacement cost figure.

For example, if the damaged portion of a plant was not protectedby automatic sprinklers, the company may have to install asprinkler system to meet local ordinances. Another example would bethat a community's recent revision of seismic codes may force anowner to replace a damaged wood joist building with a moresubstantial structure.

Labor costs to rebuild on short notice will likely exceed laborcosts for new construction that is planned months in advance. Thisis true for both partial and full losses, and would be exacerbatedif the loss was due to an event that affected a wide area.

The cost of raw materials has recently increased tremendouslybecause of the demand by countries with growing economies andgeographic regions rebuilding from catastrophes. This trend mayvary, but there have been growing shortages of certain types ofmaterials and longer lead times for construction. These, in turn,have driven up the price of construction as well as the businessincome exposure.

Over the past two years alone, the cost of lumber has risen 21percent; drywall, 29 percent; copper pipe, 27 percent; structuralsteel, 53 percent; and steel studs, 78 percent, according toMarshall & Swift/Boeckh, a supplier of building cost data andvaluation tools.

On a national average, construction cost increases haveconsistently outpaced inflation, with a hike of 16.8 percent fromMarch 2002 to March 2005, the company reported.

Clients also have difficulty pinpointing repair or replacementcosts for various types of machinery equipment. Generally, theycarry these items at book value, which is a depreciated value. Someequipment may be custom-designed, making it hard to fix a price,and some may not be available new without paying for additionalcapacity or features. Equipment may even be obsolete andunavailable. Thus, the client may have to choose a moresophisticated model or another piece of equipment that performs asimilar function but is configured differently and costs more.

As difficult as valuing building and equipment can be, businessowners can be even more unrealistic in estimating the cost andduration of a business interruption. In fact, evaluation andidentification of the exposure and the controls necessary tomitigate the potential for a loss can be a significant engineeringfeat.

Insurance carriers can assist their clients in determining theirbusiness interruption exposures, but businesses still must take thelead and spend the time to determine the exact extent of theseexposures. Often, insureds will confidently project an interruptionof only three-to-six months.

What they don't take into account are the many obstacles thatdamage to buildings or machinery can present. If they lack criticalspare parts on site or don't have other backups readily obtainable,the downtime can be far more significant than anticipated.

If a business has a single location that is hit by a major fire,it may be fairly easy to predict how long it will take to restoreoperations.

In the case of a regional disaster--post-hurricane New Orleansis a prime example--where thousands of businesses and residencesmay be affected, building materials and labor may become scarce andthe demand so great that a business owner may not be able to get acontractor to his site in a timely fashion. Also, firms dependenton a major supplier or a major customer risk losing all controlover the situation if the supplier or customer encounters asignificant business interruption.

With many unknowns, the best way to arrive at an accuratecommercial property valuation for building is through an appraisal.Since book value may or may not correlate closely to what thereplacement cost is, understanding the cost of construction is key.Business owners usually don't have expertise to determine this, buttheir broker or insurance company does and can provide appraisalson building and business interruption values.

As for contents and equipment, there's no precise way ofdetermining replacement cost unless it's done on an item-by-itembasis. A first step would be to contact the manufacturer anddiscuss the current replacement values of the equipment. Usedequipment markets should be checked to review the availability ofequipment of like kind and quality. It's also helpful to considerthe availability of critical spare parts.

From a business interruption standpoint, clients should evaluatetheir vulnerability to various types of losses and formulate adisaster recovery plan. In the case of custom-designed or obsoleteequipment, they should create a spare-parts reserve, thuseliminating or reducing the downtime of equipment andprocesses.

Insurance carriers, agents and brokers can work with theircommercial clients to help them determine the true replacementvalue of their buildings and equipment and the nature and scope oftheir business interruption exposures. If both the insurer and thecustomer agree with property valuation, potential claims disputescan be averted. Failing to understand true property value, however,can prove costly for businesses as they struggle to resumeoperations after a significant loss.