We all have read enough about inflation, rising interest rates and cost of capital, but are you aware of the impact these and other factors are having on the global property insurance marketplace? At a time when financial and economic uncertainty is the norm, what can you expect from insurance companies when it comes time to renew your property insurance for your portfolio in 2023? What factors impact it the most and what can you do about it? All of these questions have a degree of subjectivity related to them, but overall increases on property insurance should be expected and can be significant in some cases so we advise you to be prepared. Two of the main drivers are rate increases and insurance to value.
Insured losses from natural catastrophes, such as Hurricane Ida (2021) and Hurricane Ian (2022) have had a significant impact on the profitability of insurance and reinsurance companies. According to the National Oceanic and Atmospheric Administration (NOAA), in 2022 there were 18 separate billion dollar weather and climate events costing an estimated $165 billion. Looking back further over the last seven years, there have been $122 billion dollar events totaling over $1 trillion in damages, with five of the last seven being the costliest.
This is nothing new as the market has absorbed and handled such losses in the past (i.e., Hurricane Andrew, Hurricane Katrina, Hurricane Sandy) which caused them to be better capitalized this time around, but now they are also faced with other financial and economic pressures that are causing them to look critically at all factors that could impact their balance sheet. Volatility related to CAT-exposed properties has caused carriers to reduce capacity, the amount of coverage they are willing to write, as well as seek rate increases. Insurance pricing has always been subjected to supply and demand and with the reduction in capacity, particularly for CAT-exposed properties, supply is down, while demand is increasing or remaining the same. While this could be seen as only a Florida issue (or other areas commonly affected by natural catastrophes), the ripples are felt across the market and most, if not all property risks are experiencing rate increases of 10-25%, depending on losses and where they are located. For CAT-exposed properties with loss activity, rate increases at a minimum are in the 35% range. Even as we get into 2023, many insurance and reinsurance carriers have not settled on their terms for the year so it remains a very fluid property marketplace.
Insurance to Value
There has been a significant jump in building and construction costs that have caused projects to be shelved as well as delaying delivery on projects under construction. Construction Price Indexes are up across the board which causes insurance companies to question the replacement cost of buildings they insure. “Given the continued rise of labor and material costs, CBRE’s Construction Cost Index predicts a 14.1% increase in construction costs by the end of 2022. These increases are expected to stabilize in the 2-4% range throughout 2023 and 2024, in line with the average historical increases.” While this trend is projected to be lower for 2023, Insurance carriers are estimating that most insurance values still need to catch up and are off by as much as 30%
For reference, premium for property policies is calculated by rate times insured values (per $100). For example, the premium for a $10,000,000 building with a rate of $0.20 is 10,000,000/100 x .20 = $20,000. The $10,000,000 is based on replacement cost of the building and if the cost to rebuild the building with current costs increases by 30% then the premium would go up to $26,000 before any change or increase in rate discussed above. Carriers look to cost per square foot of a building to determine if appropriately valued. If they are undervalued, they will increase the replacement cost value. For example, if your stated replacement cost for a 100,000 square foot building is $10,000,000 or $100 per foot and the cost to rebuild a similar building in your market is $130 per foot, the carrier will look to increase the replacement cost value of the property to $13,000,000. That, along with expected rate increases, can cause the year over year increase to be north of 50%.
What You Can Do
First thing you can do is to be prepared. Insurance cost is just another factor in your net operating income for the asset. Be realistic on your projections as well as expected capitalization rates on an acquisition. There are a lot of factors that go into insurance costs so talk to someone with knowledge of the market. Next, evaluate the replacement cost of your portfolio. If there are properties that are significantly underinsured, proactively discuss a plan with the insurance market to increase them over time rather than get hit all at once with rate and value increases. Lastly, evaluate your property insurance program. This should entail exploring a wide marketing effort to see what other carries might have interest in your business or evaluating alternative limit and deductible structures. Either way, work with a broker that has market knowledge and relationships as well as capabilities to analyze alternative structures. As a final note, these issues are not exclusive to insurance for a portfolio. They are having similar impact on builders risk insurance for renovations or new construction, so revisit your proforma for insurance costs to make sure the project will still meet its expectations.