Real Estate Owners Navigate the Hardening Property and Casualty Insurance Market

"Unprecedented" is the word we often use to describe the far-reaching effects COVID-19 is having on nearly every aspect of our lives.

Today, many real estate owners are dealing with financially-strapped tenants who cannot pay rent. Some tenants are going out of business due to shut-downs, and others are ending their leases as they maintain a work from home structure for their employees.

Property managers and owners also worry that many companies will continue to allow their employees to work from home. This trend could significantly alter commercial real estate occupancy—and the businesses that serve those office workers.

To help gain perspective during these challenging times, many of us look to history. While research on the 1918 flu provides some insight into a pandemic, American insurance experts need only go back three decades to recall the last major industry upheaval. There are some similarities between the commercial real estate market conditions of 2020 and the industry crisis of the 1980s.

A History of P&C Insurance Rates

Let's take a brief look at what happened then. In the early 1980s, commercial real estate boomed. Interest rates reached extraordinary levels, and insurance companies responded by lowering prices. Then, when interest rates dropped, many insurers found themselves paying costly claims on underpriced policies. In addition, some real estate projects, which had been financed by savings and loans, became investment debacles. Faced with huge losses, the insurance industry increased premiums and reduced the availability of coverage.

Now, after two decades of a soft, buyer-friendly insurance market, we are facing a quickly hardening market. As you would expect, the second quarter results reflect the COVID-19 shut-downs, and they are bleak. According to the Standard & Poor's Global Index, lower investment returns, mark-to-market losses and an increased number of claims will erode insurers' earnings this year.

The rating agency has warned that an ongoing or resurgent pandemic could also impact carriers' capital buffers as financial market losses and insurance claims continue to mount. One aggressive scenario claims the pandemic could generate up to $140 billion of losses.

First quarter total global reinsurance capital was $590 billion, down $35 billion (or six percent) from the end of 2019. This result includes a six percent drop in traditional reinsurance and a four percent drop in alternative capital ($15 billion trapped from losses that now include those related to COVID-19).

The pandemic comes at a time when the Property and Casualty (P&C) insurance industry already had been losing money. Non-catastrophe losses, such as hail and water damage, have been increasing at an accelerated rate over the last several years. The combined ratio (losses plus expenses relative to premium) for the industry has exceeded 100 percent in six of the last nine years. Only 2013–2015 were profitable due to unusually low losses from natural disasters during those years.

While it is too early to know the full impact COVID-19 will have on real estate owners and the insurance industry, we expect many insurers and reinsurers will be forced to delay or cancel dividends and increase equity raising efforts.

We would like to offer a general overview of the various insurance segments at the end of Q2 and then suggest some proactive steps to take during this uncertain time.

The Property Insurance Market

The property insurance market is in a state of transition as carriers tighten terms and conditions. We see carriers taking the following actions.

• Increasing premiums and deductibles, especially with respect to water damage and hail damage claims
• Reducing their limits/capacity, especially for catastrophe (CAT)-exposed real estate schedules
• Scrutinizing properties located near or in wildfire areas, often declining to afford coverage at all or charging extraordinary rate and premium increases
• Examining the adequacy of building replacement costs/values, either declining any perceived undervaluation or quoting with "coinsurance" restrictions
• Requiring more engineering, pre-inspections and loss control questions
• Limiting interest in residential exposures, particularly wood frame construction.

Builders' Risk Insurance Rates

Rates continue to increase, with smaller increases (flat to five percent) for commercial non-combustible projects and much larger increases up to 50% for wood-frame projects. Here are some current trends to consider.

Wood-frame capacity is severely limited. Wood-frame construction usually requires quota share (with multiple insurers) layers for projects more than $25 million in construction value which tends to drive up overall insurance costs.

Heightened security is required due to increasing losses, some as the result of arson.

Developers need to pay closer attention to their general contractor's financial condition, experience, loss history and site controls.

Casualty Insurance Market

Both General and Umbrella/Excess Liability rate increases continue to accelerate, depending on loss history and occupancy. For example, there are higher rate increases for pure residential or heavy frame schedules especially when there is no supporting property or other lines of coverage with some carriers.

General Liability Rates

In terms of Primary General Liability, limited appetite or coverage restrictions exist for real estate owners who are actively developing, although there is a potential to negotiate coverage carve-backs for minor renovations or small Tenant Improvement projects. As a consequence, ground-up development projects often need to be placed in stand-alone or Owner Controlled Insurance Programs (OCIPs) which drives up insurance costs.

Workers' Compensation Insurance Rates

Workers' Compensation (WC) rates, which have been relatively flat or trending downward are anticipated to increase 5% for most risks. WC rates in California remain much higher than most states, although carriers are beginning to increase base rates in other states.

Umbrella and Excess Liability Insurance Market

The Umbrella/Excess Liability marketplace is especially challenging, with rates increasing anywhere from 10 to 200 percent, depending on risk profile and loss experience. We are seeing a dramatic reduction in layer capacity, including $50M policies being reduced to $10M. Some July 1 accounts renewed with "holes" in their Umbrella/Excess Liability towers and many owners elected to reduce their overall limits in order to mitigate costs.

Q2 Insurance Market Results Impacting Other Lines of Insurance

• Directors & Officers/General Partnership Liability increased 10 to 15%.
• Errors & Omissions increased 15 to 20%.
• Crime increased 5 to 10%.
• Cyber increased 5 to 10%.
• Environmental showed a 0 to 10% increase.

Steps Real Estate Owners Can Take Now to Reduce Insurance Rates

With so much uncertainty facing our communities, our nation and our world, it's easy to focus on the negatives. However, we see some ways real estate owners and developers can take positive steps now for the future. We recommend the following five action steps.

1. Proactively address how you are managing COVID-related risks to your facilities, tenants, and employees. Be prepared to document your cleaning protocols and other ways you are providing a healthy and safe environment. Keep up with the latest national and local regulations and address them quickly and reliably.
2. Exercise risk management controls. Now is the time to make any changes or improvements in your property to mitigate risk. Let's say you have a wood plank walkway. Make any necessary repairs or replacements now, and document those changes
3. Develop a relationship with your underwriters. It's not enough to know the name of the company; get to know the person handling your account. It's much easier to ask questions and make changes when you are dealing with someone you have gotten to know and respect and who knows and respects you
4. Consider alternative program designs, retention and deductibles, and revisit other approaches to your risk and insurance protection. Re-evaluate what you are buying and how much you are buying.
5. Start early—several months before your policy renewal date—to develop a strategy with your broker and carriers. Clarify underwriting details and engage with carrier management to tell your story. Communicate your efforts to improve your risk profile, claims history and any changes in the nature of your operations. Clearly outline your coverage expectations and pricing targets using broker market data.

Yes, "unprecedented" describes the unique times in which we are living. Many of us involved with real estate are wondering about the future of the office sector in particular.

How many employees will continue to work from home after the pandemic? Will a hybrid workweek arrangement—such as three days at home combined with two days at the office—become the new normal? Will the demand for office space decline, or will the need to offer more distance between workspaces create a demand for more square-footage?

We don't yet know the answers to these and other questions, but we do know the real estate insurance industry has been through large shake-ups before and will make it through this one as well. We at Woodruff Sawyer are here to help you mitigate any additional risk factors and costs during these unprecedented times.