Commercial property owners would be wise to have a solid understanding of the property and casualty insurance market as they plan for the year ahead and consider making changes to their real estate portfolios. They need to consider the current state of the market, what impacts insurability and prices, and strategies for securing desirable coverage, particularly in locations considered to be 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, it 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 have been relatively flat or declining—in some cases dropping by 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, the 9/11 terrorist attacks of 2001, and Hurricane Sandy in 2012. Conversely, we had 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 change. While the previous year’s insured disasters are 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 owner’s 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. 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 catastrophe-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 catastrophe-exposed properties. On a portfolio basis, understanding where property values lie will better prepare owners for discussions with insurance underwriters, as well as setting the proper limits and deductibles that 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 a large concentration of exposures—or worse yet, a concentration of property in a catastrophe-exposed territory.
Focus should also be on the construction aspects of the properties, and improvements to 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 impact 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.
Among the measures 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. Since these alternate funding mechanisms are not without risk, property owners should focus on sound risk management techniques to protect their properties from loss. Frequent inspections, maintenance schedules and capital improvements can all help ensure that the properties are well protected.
While we don’t know what will be the driving factor behind market fluctuations, history has told us that insured disasters have had a large impact on the insurance market. Commercial property owners should consider this volatility when building or acquiring in catastrophe-prone areas. The fluctuations in the insurance market can mislead property executives into thinking that the rates for insurance they currently carry on a 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 impacts 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.
Kevin Smith is a vice president and leader of the real estate division at The Graham Co., a property and casualty insurance and employee benefits brokerage firm. He can be reached at [email protected] or (215) 701-5323. Follow The Graham Co. on Twitter at @TheGrahamCo.