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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. 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, policy holders 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. 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 cost has 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 catastrophe reinsurers 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.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.
