As commercial real estate property insurance costs continue to rise, many investors are faced with tough decisions regarding how to manage and mitigate these expenses. This challenge is especially pronounced in high-risk areas susceptible to natural disasters, as climate change and increased claims drive premiums higher. A new report, "Insurance on the Rise: Climate Risk and Real Estate Investment Decisions" by the Urban Land Institute and real estate investment manager Heitman, highlights emerging strategies to manage these growing costs, with insights from industry experts.
Facing the Insurance Challenge
Investors are experiencing increased pressure not only from insurers but also from lenders, who are imposing higher underwriting standards and stricter coverage requirements. These constraints add an extra layer of complexity, often exceeding the recommendations from insurance brokers and further impacting borrowing costs. The report attributes the increase in property insurance costs to a combination of factors: a higher frequency of weather-related claims, scarce and expensive reinsurance options, persistent inflation, and stringent regulatory conditions.
For owners, these changes have significant financial implications. The report notes that rising premiums are causing lower net operating incomes (NOIs), failed deals, and declining property valuations. In response, investors are taking on additional financial risk and getting creative with their insurance strategies.
Layered and Captive Coverage as Solutions
One solution gaining traction is "layered coverage," which involves consolidating coverage from multiple insurers under a master program. This approach provides flexibility, as investors can tap into a wide array of insurers to meet the required coverage. Within this layered approach, owners can also add "buffer layers" to bolster protection. These additional policies cover specific types of losses above the primary coverage limits, providing extra assurance for catastrophic events.
Captive insurance is another approach that some investors are exploring. In this model, an investment firm creates its own insurance entity, insuring itself against certain risks. Captive insurance requires a thorough evaluation of expected losses and can offer substantial premium savings in the long term, though it comes with regulatory challenges and may affect financial statements, which some lenders find concerning.
Alternative Deductible Structures and Self-Insurance
To cope with premium increases, some property owners are shifting to higher-deductible policies, which can significantly reduce annual premiums. In some cases, owners are opting for "aggregate deductibles" that cover all claims over a policy period rather than per-incident deductibles. While these arrangements can be cost-effective, they often conflict with lender requirements, necessitating negotiations to ensure compliance.
Self-insurance, where a company assumes a portion of its risk by setting aside funds, is another strategy for certain firms. This option allows for more control over claims and premiums but involves a careful analysis of potential losses against the costs saved by not insuring externally. Pooling risks with other companies in a self-insurance consortium is another route that some property owners are finding advantageous, allowing them to spread risk across a larger portfolio.
Specialty Insurance and Parametric Policies
For properties in high-risk locations, traditional insurance can be costly and difficult to secure. As a result, investors are turning to "excess and surplus line" (E&S) coverage, which is designed for high-risk properties that mainstream insurers may avoid. E&S insurance has become essential in states where multifamily and commercial properties face significant natural disaster risks. With its flexibility and growing market share, E&S coverage is increasingly vital for properties that standard insurance providers refuse to underwrite.
Parametric insurance, which pays out based on specific "trigger events," is also emerging as a viable option. For instance, a policy might cover hurricane damages if wind speeds exceed a certain threshold within a defined area, regardless of the actual damages incurred. Parametric insurance offers streamlined claims processes and quicker payouts, allowing owners to more effectively manage cash flow during disruptive events.
Strengthening Risk Profiles and Building Resilient Relationships
Given the complexities of modern insurance, industry experts emphasize the importance of collaboration and proactive risk management. Some investors are starting insurance renewal discussions earlier and relying on knowledgeable brokers to navigate today’s complex market. For those with the resources, hiring in-house insurance specialists or consulting third-party advisors ensures higher-quality data and facilitates a more structured approach to risk management.
Insurers are also seeking detailed property information, particularly related to building resilience. Age and condition are critical factors, with roof age, structural design, and construction materials all impacting insurance costs and eligibility. In high-risk regions, these considerations are essential for determining policy terms and rates.
Investors are responding by cultivating strong relationships with insurance brokers, lenders, and regulators. Through transparent communication and a high-quality data collection process, property owners can position themselves more favorably with insurers, demonstrating their commitment to minimizing risk.
Balancing Portfolios for Greater Resilience
Despite the ongoing cost challenges, investors aren’t shying away from high-risk areas entirely; instead, they’re taking a cautious approach by diversifying portfolios across different regions and property types. By leveraging size and diversity, investors can present a more attractive profile to insurers, making it easier to negotiate favorable terms.
Additionally, the report notes that while some investors are piloting methodologies for predicting future insurance costs, there’s no reliable solution yet. Nevertheless, they remain committed to finding strategies that balance portfolio growth with protection against escalating insurance rates.
With insurance costs on the rise, commercial real estate investors face an evolving landscape where risk management has become integral to maintaining profitability. By implementing layered insurance strategies, exploring alternative deductible structures, and strengthening partnerships with insurers and lenders, property owners are adapting to this new reality. For those willing to innovate and seek alternative insurance models, there are clear opportunities to safeguard investments and thrive in the face of uncertainty.
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