Habitational real estate property owners and managers face a tough renewal season, insurance experts warn. Weather-related losses added insult to insurers already underpriced property rates in the past 12 months. Wind, tornadoes and hail damage compounded by shrinking capacity will force rates up, often with increased deductibles. Higher deductibles can create problems for owners if they have lender requirements that require a low deductible or retention. To provide assistance in this tightening insurance market, we will outline the building blocks insurers use to assess habitational real estate insurance risks.
Insurance Challenges Commercial Real Estate Owners Face
A Business Insurance source predicted that market capacity, the availability of insurance nationally and in reinsurance markets, might decline by “as much as 50%.” With that decrease in market capacity, real estate managers face spiking rates, from approximately 10% to 20% in good risks. In risks with losses, insurers are increasing rates by 30% to 50%. Property owners also face difficult market placement, in some cases facing non-renewals. While the habitational industry enjoyed flat property rates for some time, these increases will be difficult to manage without passing on costs to tenants. Additionally, because most real estate managers own assets individually, higher insurance costs mean less revenue on the profit and loss statement. These types of market swings will ultimately affect the market valuation of commercial properties.
What are some of the challenges habitational real estate must now consider? Don’t look much farther than the standard acronym, COPE; construction, occupancy, protection and exposure. COPE is the underwriting building block used to evaluate and price real estate property habitational risks.
Construction in COPE analyzes the building materials used to construct a building. The majority of apartment complexes today are stick built—frame construction—which is cheaper than masonry and quick to construct. According to Bloomberg Business, the abundance of frame covered with stucco, metal or brick is “one of the most dramatic changes to the country’s built environment in decades.” A ground floor parking lot or retail space under five stories of frame construction, also called “five over one,” are the new markers of urban infill nationwide.
Most builders use two-by-fours for the frame, and then add a surface. A chronic shortage of skilled construction labor means contractors strive to keep construction methods simple. Wood is much more forgiving and easier to acquire with a Home Depot trip than hardier building materials. Material preference and a lack of labor push today’s habitational builders toward stick construction. Wood also makes it easier to avoid using higher-paid, more skilled union laborers.
Another factor with wood construction is its price – from 20% to 40% less than steel, masonry, or concrete, according to Bloomberg. Not all cities are on board with stick construction, however. Building codes may prevent wood construction in dense urban neighborhoods like the Bronx and Manhattan.
For insurance company underwriting purposes, frame construction due to its combustibility, increases rates and decreases limits for the insured. One risk in most of these older buildings is a lack of sprinklers. Due to the emerging urban landfill faced by cities like Phoenix, where developers demolish aging strip malls to build multi-family housing, new habitational risks are in close proximity to adjacent buildings.
Occupancy answers this question: How is this building used – as an office, a restaurant, or is it a habitational risk? An office as an example is less of a hazardous risk than a car repair shop. The risks associated with 24-hour tenant occupancy have insurers concerned. A more litigious public, increased third-party liability and more favorable tenant-landlord laws mean more exposures for building owners and their insurers. Increased litigation involving habitational properties have also pushed rates higher.
Protection considerations in underwriting include the quality of the responding fire department, water supply, and fire-suppression systems. Frame habitational risks in particular now demand higher rates and lower limits. A lack of sprinklers, alarms, fire hydrants, and buildings in close proximity to other buildings pose an increased risk to underwriters.
The exposure looks to other risks present in the surrounding area. High-crime areas, such as downtown Los Angeles for example, face significantly higher rates. Now popular wildland-urban interface areas located in flood zones or where the risk of wildfire is high will generate higher premiums. In many “plaintiff-friendly” jurisdictions, habitational risks cause defense expenses and higher jury verdicts for insurers who defend these cases, which may result in rate increases for such jurisdictions.
Property owners should limit their liability through solid indemnification agreements in their tenant lease language. Owners can require prospective tenants to purchase tenants homeowners’ policies and institute solid background checks. In addition, a strong maintenance program including snow clearance, fire-suppression systems servicing and other steps can help reduce the chance of losses and impress underwriters who are more skeptical in today’s legal and weather-challenged environment.
Steps Insurers Take to Limit Risk in Habitational Exposures
As the real estate insurance market continues to harden, habitational risk managers may face three possibilities from carriers. These include the following.
- Carriers will decline to write coverage for the property, the liability, or both.
- Carriers may exclude certain types of coverage, for example removing endorsements for replacement cost coverage and replacing coverage with a more restricted form.
- Carriers will limit their exposure by offering reduced limits of property and/or liability coverage.
In today’s market, it is imperative to work with a broker who understands the intricacies of placing habitational real estate risks. Underwriters today are skittish and comprehensive coverage has become harder to acquire. A broker with deep ties to the habitational insurance risk market can help present a habitational risk in its best light.
With a tightening market environment for habitational risk, a solid risk management program that highlights the strengths of a habitational account to underwriters becomes paramount. Providing underwriters with extended loss histories, discussing key risk management techniques that your organization is implementing, and highlighting strong tenant-management techniques can mean the difference between a barely satisfactory insurance placement and one that provides broad coverage and maximizes the commercial investor’s bottom line.