Valuation is an Art

The problem of placing a value on property, business interruption, and extra expense has always been difficult, but it has become worse because of the increasing mobility of business. Mergers, downsizing, just-in-time inventories, and re-engineering are playing havoc with valuations, especially business interruption.

Technology changes, such as increasing dependence on PCs, also are significantly altering physical inventories and time element values.

Insureds are often hurt by undervaluation, but insurers are hurt even more because blanket policies and replacement cost coverage are being applied to exposures that had not been anticipated. Insurers are concerned about the problem and are taking action, prodding insureds and hiring more specialists in valuation and accounting.

Blanket insurance has led some risk managers to relax their vigil about values, but this is short-sighted. Accurate values are important not primarily for insurance purposes, but to identify and measure risk. The scope of a loss exposure can not be known without reasonably accurate valuations of property and its indirect ó and intangible ó loss potentials.

Consider real property first. Buildings can be valued by original cost, contractor estimates, or appraisals ó and appraisals come in all sizes and flavors. The need for precision in valuation is a judgment call. With blanket insurance and no coinsurance, there is less need for precision. This is all right if the risk manager knows and accepts the range of possible imprecision. It is not all right if it introduces unknown values which could exceed tolerable levels ó not at all unusual.

Real property valuations must also include building code risks and allowances for high construction costs in times of widespread catastrophe.

Valuing personal property is much more difficult because it moves around, changes value rapidly, and has varying accounting treatments. Itís hard to know what is in a building because you have to rely on continuing reports from the field. Sometimes contents under $500 in value are expensed and not reported, but could add up in the aggregate to a substantial amount. And how about assets that are fully depreciated from a tax standpoint? Are they reported, as they should be?

And then there is the problem of semantics. Confusion sometimes exists between the accounting jargon of fixed and variable expenses, and insurance terminology of continuing and non-continuing expenses.

Then there is the added value of company-modified equipment? Are the costs of modification included with the values?

Just-in-time inventory processes are greatly increasing business interruption and contingent business interruption exposures. All the implications of loss of critical suppliers must be worked into the values.

All these points indicate a need for more attention to valuation procedures so a continuing process of reporting and physical inspections can be developed.

Increasing use is being made of accountants by both insureds and insurers, especially for time element risks. This is fine, but their work should be the basis for risk manager judgment, not the final product. Accountants, not being risk managers, canít see the whole picture.

Insurance considerations are too often primary. The main purpose of valuations is for the risk manager to know what is present, where it is, and how much direct and indirect loss exposure is presented. Then, after the risk is assessed, insurance needs can be addressed.