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Insurance turmoil

Optimizing risk management to provide more control over cost and coverage

By Mike McConnell, CPM®

“I understand this discussion is focused on ways to reduce property insurance costs, but I just want to know what I can do to get insurance coverage for my property!” That comment, made during an IREM class, illustrates the angst owners and property managers have over the current state of the commercial property insurance market. Annual premium rates are rapidly rising while coverages are being limited or reduced. Insurers are leaving markets, and many of the ones left behind are not taking on new business, making it difficult to secure adequate insurance coverage at any cost. The lack of capacity and rising rates are much worse in natural disaster-prone markets like parts of California, Louisiana, Texas, and Florida.

In 2023, Moody’s Investors Service reported insurance costs increased by 73% over five years. Hub International’s 2024 Commercial Lines Rate Report forecasts double-digit rate increases and notes that “property insurance capacity is scarce in areas where real estate owners need it most.” For 2022–2023 policy renewals, 29% of residential housing providers and 39% of commercial properties faced premium increases of 25% or more, according to ndp | analytics. Limited markets and capacity were cited as the top reasons for most premium increases.

Flooding, heatwaves, and wildfires

In 2023, both Allstate and State Farm stopped issuing new commercial property insurance policies in California. State Farm said its decision was “due to historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market.”

R. Scott deLuise, CCIM, SPPA, Adjusters International Matrix Business Consulting

R. Scott deLuise, CCIM, SPPA, CEO of Adjusters International Matrix Business Consulting, weighed in on this change. “Because of wildfires, hurricanes, and other weather-related events, the capacity for reinsurers, many of whom are located offshore, has gone down,” says deLuise. “Capacity is based on an insurer’s risk appetite, and that risk appetite has decreased.”

The past year saw increases in the number and severity of hurricanes, thunderstorms that produce extreme precipitation and flooding, and extended heatwaves with record-setting temperatures and wildfires. With these weather events and the significant increases in construction costs for both labor and materials, insurance companies are struggling to maintain profitability and viability.

Steep increases in insurance rates and decreases in capacity all threaten property owners’ profitability and the viability of their investments. According to ndp | analytics, property owners are looking to mitigate rising insurance costs by increasing insurance deductibles, decreasing operating expenses, and increasing rent.

In today’s unprecedented and difficult property insurance environment, establishing a well-developed and executed risk management plan is mandatory. Here are a few recommended strategies and tactics to consider and adopt.

Defining risk exposure

Developing a risk management plan begins with identifying risk exposures and threat levels and determining a plan for managing them using one of four strategies: control, avoidance, retention, or transfer. The plan should focus on risks unique to the property type, location, construction, and condition.

A major portion of the plan should address risk mitigation and define standards and procedures for maintaining the property in good condition, conducting regular inspections, engaging with tenants, and developing and executing emergency preparedness and response plans.

The plan should also present the financial consequences of the risks to the property and determine the methods for financing those losses. The first risk transfer option is for the owner to retain the loss and pay for it out of pocket. Every owner must determine their comfort level and threshold for self-financing. Purchasing insurance is, of course, the most common method used to finance losses; that process is addressed later in this article.

Making risk management a priority

Property owners and managers need to build a risk management culture and level of awareness where everyone in the organization understands their responsibilities (as defined in the risk management plan) for limiting risks and minimizing the impact of adverse events.

Maintaining the property in optimal condition and establishing an effective inspection routine will detect frequently occurring deficiencies and hazards. Management can then implement policies and procedures to eliminate or minimize them.

Leases and contracts must clearly define tenant and contractor liability responsibilities and required insurance coverages, and owners and managers must routinely monitor compliance.

In addition, owners and managers must develop comprehensive plans for emergency preparedness and response for perils common to their location. This includes providing emergency response training for property personnel and tenants and holding drills or tabletop exercises to evaluate the effectiveness of those response plans. A business continuity plan that provides for timely restoration of business operations is essential. This includes encouraging commercial tenants to do the same.

Designate a risk manager

Risk management responsibilities may be scattered throughout an organization, but centralizing the primary responsibility for risk management underscores its organizational significance. The risk manager is responsible for developing and overseeing the risk management plan. It’s a continuous process, requiring participation from all levels of ownership and management, as well as operations and finance, with help from an experienced risk management professional, insurance advisory consultant, or commercial insurance broker.

Centralize the claims process

The risk manager should manage the claims process and serve as the central point through which all claims and incident reports are channeled. They also should serve as the primary interface with the insurance provider and any claims adjuster. This structure supports consistency and compliance with the risk management plan relative to the loss management process.

Prepare a plan for financing losses

Although capacity in the insurance market continues to decline, making the acquisition of insurance coverage increasingly difficult and expensive, insurance is still the primary vehicle for financing losses. Owners and managers must be thoroughly prepared before purchasing insurance or securing loss financing from another source.

Whether you have a single property or a portfolio of properties, purchasing insurance coverage at affordable rates is a challenging and complex process and even more so in disaster-prone areas. For example, deLuise notes that while Citizens, the insurance provider of last resort in Florida, will likely continue to offer replacement cost insurance, it won’t insure to value because property values have become so uncertain in parts of the state. This puts property owners at risk of paying more out of pocket to restore a severely or completely destroyed property. Engaging the services of a professional insurance advisor who will advocate on your behalf is essential.

Here are some additional best practices for purchasing insurance:

  • Start the insurance purchase process early enough to allow sufficient time to identify and acquire the best value and most favorable terms.
  • Identify the risk mitigation measures you have implemented and prepare a narrative to market your risk management performance to potential insurers.
  • Promote your loss experience record unless it is unfavorable, in which case, be prepared to explain the reasons and demonstrate the improvements you have made to prevent future losses.

Loss control inspection

Consider hiring an engineer to perform a professional loss control inspection. This is a proactive approach to secure a professional evaluation of the condition of the property, identify potential risks, and get recommendations to mitigate them. The decisive step in this loss control strategy is to implement the recommendations and improve the property’s overall risk profile, which can lead to more accurate underwriting and potentially lower insurance premiums.

Identify, prioritize, and quantify the risks for which you need coverage, and establish reasonable insurable values. Recognize that recent substantial increases in construction labor and material costs have driven up replacement cost valuations. Make sure your insurable values are up to date and accurate and avoid coinsurance and underinsurance penalties. Also, determine your self-insurance risk tolerance, recognizing market conditions may dictate the amount. Keep in mind that higher deductibles result in lower premiums.

Multi-property owners should determine if blanket coverage is beneficial. Blanket insurance coverage is a type of policy that provides broad and inclusive coverage for multiple properties under a single, consolidated policy; one advantage to this approach is the potential cost savings.

Risk transfer tactics

In January 2024, Moody’s Analytics offered guidance for risk transfer tactics that may result in insurance cost savings.

  • With your lender’s approval, set insurable values for certain perils at the modeled loss cost (as determined by catastrophic loss modeling) instead of the full replacement cost. “A premium for full replacement cost for named storm damage for an asset will be substantially higher than a premium for coverage up to the estimated damage in a 1-in-200-year event,” according to Moody’s.
  • Consider parametric insurance coverage, where payouts are based on certain threshold conditions like the height of a storm surge or wind speed, rather than based on the loss incurred by the insured. This coverage provides an underwriter with a higher degree of certainty and may make them more likely to cover a high-risk area.
  • Another financing source is a “captive insurer,” referring to a wholly owned subsidiary of a company that has been created solely to provide insurance. A captive insurer is a form of self-insurance used by very large companies, and it provides flexibility in terms as well as some tax benefits.
  • Work with your insurer to understand how factors such as roof type, windows, equipment locations, and power backup bear on premium setting. Armed with this information, owners should make sure that resilience investments they’ve already made are factored into the premium rate and determine what additional investments might offer the best payback on reduced premiums.

The upheaval in the property insurance market is a threat to the profitability of all commercial properties. Although owners and managers cannot control the weather-related events and the steep construction cost increases that are driving rapidly escalating costs and limited coverage, they can counter them with a thorough and well-executed risk management plan.

Journal of Property Management

Mike McConnell, CPM®, instructs classes for IREM and others and provides consulting services on operating expense billing processes and risk management.

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