Law
The basis of amounts of insurance for commercial real estate properties is established in Russian legislation as the actual value of the property at its location on the day the insurance agreement is concluded. In addition to this, legislation is clear that insurance amounts in excess of this value are invalid, and insured amounts lower than the actual value can subject the contract owner to reimbursement of a proportionally lower recovery amount.
The most obvious issue is that the Civil Code and related regulations do not provide any definition as to what “actual value” really is. Common sources for establishing actual value include the construction cost documentation and the owner’s balance value. These sources are most applicable for new structures, while an appraiser’s estimate may be more useful for older buildings or those special structures involving historical value, elements that are currently prohibited, or specialized improvements. In any case, the value of the land, and any below ground improvements, are never included.
Another governing principle supported by the law is that insurance is a contract to reimburse the property owner for direct physical damage or loss of property. The objective is to put the insured into the same monetary position as before the loss. The maximum amount of reimbursement is limited to the value shown on the policy agreement.

Practice
An appraiser’s task is always to solve some sort of appraisal problem. Establishing the appropriate parameters of the appraisal is the first part of the solution. For appraisal of real estate rights involving insurance issues, there are no established precedents, so each new task represents a fresh challenge. Necessary parameters include deciding the definition of value that applies, the appraisal approaches, methods, and techniques to be used, and accounting for any special conditions which may exist.
Since the appraiser is likely to become involved at the time of a claim, when the insured property has changed in value, his job is particularly difficult and it is very dependent on the terms of the insurance contract. Differing terms of insurance contracts can cause large differences in the defined damage reimbursement amount. Issues in question will include the value type, the approaches to be used, and whether loss of business income should be included.
To estimate the legally required “actual value” of the insured structure when reimbursement for damage is involved, the logical basis is the market value, as it is this type of value that would have represented the insured’s monetary position before any event of damage. However, for a property of limited marketability, consumer value may apply, and liquidation value may be used by the insurance company when a property cannot be practically rebuilt.

Approaches: Cost and Income
The Cost Approach is almost always used as it is most convenient to separate the land and improvements. Most times, the insured expects to receive compensation to restore the structure to the same style and materials as the insured structure. Thus the focus is on the estimation of reproduction cost of the structure as new, less any value lost from physical deterioration or damage.
Depending on the condition of the property being appraised (totally destroyed, or only partially damaged), the appraiser may find the usually available per square meter cost indexes to be of limited use as they may contain original design, engineering, foundation and other costs that may not be applicable for this replacement project. More often, detailed analysis of the itemized costs is more useful.
Consideration of depreciation is simplified when appraising for insurance purposes, as the loss for physical factors is usually the only estimation needed. The impact of functional and economic value loss will generally be accounted for by the insurance company.
Business income loss: A common component of insurance contracts. Loss of business income as a result of an insured loss is certainly a necessary part of returning the property owner back to his original monetary position. For lost income the appraiser will likely use the Income Approach. Key determinants will be (a) the amount of shortfall of the income stream from the damaged property as compared to the original insured operations, (b) the length of time the reduced income may reasonably last, and (c) the rate of return to be credited to the cash flow. With proper inputs, this is a rather simple discounted cash flow calculation to estimate a present value amount for reimbursement to the insured.

Special Considerations
Defining items for appraisal. Real estate properties are a combination of land, below-ground improvements, foundation, structure, operating equipment, and interior decorations. We have already mentioned that the land and below-ground improvements are never the subject of typical insurance contracts, and damage to a foundation is unlikely. How much of the remaining items are included in the insurance is a matter of legal interpretation of the insurance contract.
Certain air conditioning equipment, motors, or other items may be excluded from coverage in a real estate insurance contract, as may items in the improvements that are owned by the tenant. Defining exactly what items are subject to being part of the reimbursement is a part of defining the appraisal problem. It means that familiarity with the insurance contract, tenant leases, Russian law, insurance regulations and the characteristics of the property will all be necessary to properly define the subject of the appraisal.
Regulatory changes. The insurance is intended to insure the same structure on the same site as it stands on the effective date of the insurance contract. However by the time of a loss, regulations may have changed so that the original building is no longer allowed in its same configuration. Fire, safety or other construction norms may have changed. Uses, volumes, building heights, or other physical parameters permitted in the area may also have changed. In this case, the appraisal problem may concern a non-existent and theoretical replacement building.
Historical structures. The materials and techniques used for construction of historical or specialized properties may no longer be available, or financially feasible. In this case, an appraiser’s assignment may require use of the replacement cost using functional equivalents.

Conclusions
Even though most appraisal work for insurance purposes is limited to the Cost Approach or basic discounted cash flow analysis, it is not so simple. As in many appraisal situations, the determination of the problem to be solved is as complicated as the solution itself. Because of our young but active market, appraisers in Russia are accustomed to completing value estimates of rights to completed property, and are not accustomed to dealing with only the structure as required for insurance work. Adjusting to this limited component of a property, and using only the specific approaches that can properly measure this separate value, is a big change and requires attention to detail to avoid errors. Insureds and insurers alike will benefit from cooperating fully with the appraiser to be sure that all elements to properly define the appraisal task are fully disclosed and understood.