Why are Property Insurance Premiums so Unpredictable?

Every real estate owner, manager and developer would like insurance to be predictable. How can you model an acquisition, the post-development expenses or a long-term lease without estimating insurance cost over the next several years? Retail and office tenants want to find a way to cap the insurance expense charged back by landlords. This request during lease negotiations should never be entertained by real estate owner! Ask any risk manager or broker with real estate expertise, insurance rates across various lines of coverage have been extremely volatile over past five years. Why?  Let’s talk about property insurance.

Climate Change and Catastrophic Events

Frequency of catastrophic weather events has played a major role in shaping the insurance marketplace over the last decade. A major hurricane has made landfall in the U.S. five out of the last six years. In 2022,we experienced 14 named wind events, including Hurricanes Ian and Nicole, which made landfall.

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According to the Insurance Information Institute, Hurricane Ida (2021) was the second costliest hurricane on record, with $36 billion in insured losses. Top of the list is Hurricane Katrina, with approximately a $90 billion insured loss in 2021 dollars. Hurricane Ian is currently estimated to be a $40-60 billion insured loss event. It is not just hurricanes that wreaked havoc on insurance profitability. Between 2021 and 2022, wildfires accounted for over $11.2 billion in damage across the United States.Globally, insured losses from natural catastrophes reached $130 billion in 2021 — 18% higher than 2020.

Fraud and Bad Data

In Florida, policyholders were allowed to sign over their insurance benefits to a third party, such as a roofer or plumber as a means of payment for services. This is known as the Assignment of Benefits (AOB) provision in the policies. It was intended to allow distraught homeowners who had lost everything in a hurricane to obtain contractor services without having to pay upfront cost. Unfortunately, this created an opportunity for many contractors to soliciting homeowners to provide a full replacement of their roofs with little or no damage. The contractor provided the proof of the loss documentation to the insurance companies and the homeowner received a new roof that possibly only needed a slight repair or did not even need repairs at all. Another challenge in Florida is One-way Attorney Fees. Initially designed as a way to ensure poor homeowners could sue large insurance companies, the practice allowed plaintiff attorneys to collect compensation from the carriers for their fees regardless of the outcome. This led to the filing of numerous lawsuits due to the misalignment of fiscal incentives in favor of the plaintiff attorney.Florida accounts for 76% of the nation’s homeowners’ insurance lawsuits but just 9% of all homeowners’ insurance claims.Given the magnitude of insurance fraud and litigation brought against insurance companies in Florida, insurance is becoming extremely expensive and unobtainable for homeowners. Bill SB-2A, approved by Florida Governor on December 16, 2022, should mitigate some of this type of insurance fraud and overtime encourage new insurance markets to write in Florida.

“It is not just hurricanes that wreaked havoc on insurance profitability. Between 2021 and 2022, wildfires accounted for over $11.2 billion in damage across the United States.”

Large real estate portfolios with blanket property limits have a reputation in the insurance industry of underreporting replacement cost building values. Replacement Cost Values is the amount required to restore an entire building in the event of a total loss. In prior years, insurance companies were more forgiving or less focused on valuations as total building losses were rare. Recent catastrophic events such as wildfires and hurricanes where entire cities were destroyed, coupled with increased construction costhas highlighted the fact that the actual cost to replace a building was significantly more than what had been reported on an insurance schedule. This meant that premiums paid were sometimes twenty-five or fifty percent less than should have been collected. This has made insurance renewal conversations strained as insureds are faced with increasing their valuations to appropriate levels and paying increased rates due to loss experience.

Reinsurance Capacity

The latest issue is lack of reinsurance for catastrophic events. Property catastrophereinsurers provide cover to insurers that offer insurance quotes to real estate firms. Hurricane Ian damage estimates are putting losses at $47B - $60B.Average insured losses over the past 10 years are around $81B. Earnings for reinsurers have been wiped out for the past five years by disasters. Rising prices is to be expected. However, despite five years of unprofitable results, prices did not rise. This was due to excess capital in the reinsurance industry. In the past decade alternative sources of capital from hedge funds, catastrophe bonds and other similar products provided extra capacity into the market keeping premiums low.

Persistently low interest rates following the global financial crisis drew many new investors to the reinsurance market in search of better returns than were available from financial markets. In more recent years, insurance-linked securities (ILS) investors have pulled back from the market following several years of above-average catastrophe losses. There are significant amounts of trapped capital in ILS, while higher interest rates are making non-insurance assets more attractive with less volatility. It is estimated that 15% or more of the reinsurance capital has dried up. Globally, there is likely a $25B - $50B shortfall in capacity. A continuation of this trend will extend the hardening market and result in higher rates for CAT limits in your insurance program.

What can you do to minimize your exposure to the ups and downs of the insurance marketplace?

Valuation and good data - If you do not have a risk management department, consider hiring a loss control consultant to visit your properties and gather the data that your acquisition department is not telling you. Frequently, the schedule of locations that a real estate firm provides to an insurance broker is missing critical information or the information is incorrect. A detailed schedule showing age of the building, roof and specific building characteristics that protect it during a hurricane, storm surge or earthquake is critical in helping an insurance broker determine the appropriate limits and obtaining the best pricing. Consider having a loss control engineer visit your Florida, all coastal and California properties to collect the secondary characteristics. These consultants can advise you on what steps to take to make your buildings better able to withstand a loss or provide tools to help detect water leaks before a large claim occurs. Small investments in improving your risk and a few years of better claims experience, goes a long way in reducing your insurance rates.

Use an insurance broker that is well versed in the real estate insurance market. Not all insurance brokers are alike. You wouldnot go to a divorce attorney to assist you with a criminal case, you should not use a general insurance broker (even if he is your brother in law) for handling a large real estate portfolio.

Build strong relationships with key insurance companies. Develop relationships with insurance companies thatuse “house” money and do not rely on reinsurance to offer CAT coverage. FM Global, Berkshire Hathaway, Sompo, Chubb are all markets that are not heavily reliant on reinsurance. Small markets or syndicates that offer competitive quotes one year and disappear from the landscape the next are good for your excess layers or as a small percentage of your program. However, your primary relationships should be with financially stable markets that are committed to the real estate industry and will renew your account year after year.  If you have a good story to tell, meet with your insurance partners annually to tell your story of how you are improving your risk and lowering your claims cost. They are not your adversary; they are your business partner.

Self-insure – putting more skin in the game. When you are willing to shoulder the smaller and more frequent losses that slightly bleed over your current $25,000 or $50,000 deductible, the insurance companies quoting will provide a sizable credit off the premium. Cutting the indirect cost of claims handling person, third party adjuster fees, and accounting personnel to issue numerous small payments is worth something to them. Unlike your homeowners or personal auto insurance claim handling, large commercial insurance companies are not staffed to handle the frequency of small claims under $250,000. A loss fund can be established and over a few years, you can use the surplus to help minimize fluctuating insurance rates.