This article originally published on Commercial Property Executive’s website on January 19, 2015.
By Kevin D. Smith, CPCU, ARM, Vice President
As commercial property owners plan for the year ahead and consider making changes to their real estate portfolios, they are wise to have a solid understanding of the property and casualty insurance market – the current state of the market, what impacts insurability and prices, and strategies for securing desirable coverage, particularly in locations considered high-risk.
Following the insurance market can best be described as taking a ride on a pogo stick, however, if you take a closer look at the market’s history you’ll see that although at times it is volatile, the market is also cyclical. There are many factors that impact these fluctuations in the insurance market – interest rates, inflation, economic growth and natural disasters, all of which are difficult to predict. That said, the property and casualty insurance market in 2015 is poised to be favorable for property owners since the insurance industry has benefited from steady growth over the past few years as well as lower natural disaster insured losses.
The industry has benefited from the economic recovery over the past few years with an increase in new developments as well as additional capital entering the market. With the volatility of the insurance market, property executives should take into account potential insurability and price changes for properties they are constructing or acquiring now or in the future. While property insurance rates were relatively flat or declining, in some cases as much as 5 percent going into this year, history would suggest this should not be viewed as the new normal.
The property insurance market is heavily impacted by major insured disasters. For example, insurance company profitability declined and rates subsequently rose following events such as Hurricane Andrew in 1992, the Northridge Earthquake in 1994, 9/11 terrorist attack, and Hurricane Sandy in 2012. Conversely, the extended soft market period of the late 90s, which was largely due to the lowest catastrophic insured losses in 15 years combined with economic growth. Historical data suggests that the one constant with the property insurance market is always change. While the previous year’s insured disasters is certainly a leading indicator for the performance of the insurance market and rates going forward, change is difficult to predict over the long-term.
While location, location, location always reigns true for the marketability of real estate, location can also be the driving factor for a property owners’ exposure to risk. According to the Insurance Information Institute, the insured value of coastal property in the United States has risen by nearly 50 percent since 2004 to an excess of $10 trillion dollars. In addition, properties in cities such as New York, D.C. or Los Angeles face a significantly higher risk of terrorist attacks than properties in Cleveland, Des Moines, or Pittsburgh.
Properties in high-risk locations will see the most volatility in pricing following wind, flooding, and other catastrophic driven events. It is extremely important when approaching insurance companies that a proper analysis has been done to model properties and segregate them by location (state, county, etc.), age, construction type, and concentration with a particular emphasis on catastrophic-exposed properties. On a portfolio basis, understanding where property values lie will better prepare property owners for discussions with insurance underwriters as well as setting the proper limits and deductibles which have a direct impact on costs. Risks that can emphasize the geographic spread of the properties will be viewed more favorably than a risk with large concentration of exposures, or worse yet, a concentration of property in a catastrophic-exposed territory.
In addition, focus should also be on the construction aspects of the properties, and improvements and protection of those properties. While there is little property owners can do about the actual construction of a property that has been acquired, there are many improvements that can improve the risk profile of a building, for example, updates to electrical systems and fire protection. Disaster planning also becomes an important component of an overall risk management plan to be prepared to react quickly to a loss and for a speedy recovery.
Some measures that commercial property owners can take to remove some of the volatility of the insurance marketplace is utilizing alternative funding mechanisms for their property insurance. By taking on more risk, property owners will in turn purchase less insurance from the marketplace and be in a position to smooth out large increases or decreases caused by market conditions. These strategies are typically utilized for larger portfolios that can withstand higher deductibles and have a spread of risk. These alternate funding mechanisms are not without risk so as a result property owners should focus on sound risk management techniques to protect their properties from loss. Frequent inspections, maintenance schedules, and capital improvements all can have an impact on insuring the properties are well protected.
While we don’t know what will be the driving factor behind market fluctuations, the one constant is change. History has told us that insured disasters have had a large impact on the insurance market. As a result, commercial property owners should consider this volatility when building or making acquisitions in catastrophic-prone areas. The fluctuations in the insurance market can mislead property executives into thinking that the insurance rates they currently carry on the property will continue into the future. While direct losses at individual properties will have the most impact on pricing, it is not the only factor to consider when forecasting insurance costs for properties. Global disasters impact the entire insurance marketplace, which in turn, impact property rates across the industry. While it is felt much more with properties exposed to catastrophic losses, the performance of the insurance industry as a result of insured disasters certainly moves the needle on rates across the board.
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