Hurricanes, earthquakes, terrorist attacks: If your apartment property could potentially be damaged by any of these things, then renewing your property insurance policy probably will be a painful experience this year.
Apartment owners who renew their property insurance policies this fall could see the cost of their premiums rise by as much as 150 percent more than last year if they own apartments in areas that are at risk of these kinds of catastrophic losses, according to Mark Franco Sr., president of Alpha Risk Services, a risk management company.
For example, the cost of a master insurance policy for one Florida property more than doubled from less than $600 per unit to $1,300 per unit when the owners renewed the policy earlier this year, according to information from Chuck McDaniel, president and CEO for Lockton Companies of Colorado, Inc., a national insurance brokerage firm.
Insurance costs for apartment properties in the rest of the country have risen 10 percent to 20 percent, Franco said. That’s much less than the losses faced by properties at risk of catastrophic losses, but it’s still a significant increase.
Even at these high prices, insurance companies are offering less coverage. Most policies now demand that all claims for damages caused by a named storm have a deductible based on a percentage of the claim, and that percentage has risen from 2 percent to 5 percent in the last year. Retentions, which are a type of deductible covering all the properties in a policy that are affected by a single occurrence like a hurricane, have also doubled, experts say.
Storms hit the insurance business
In 2005, the Atlantic hurricane season shattered many assumptions for the insurance industry. Weather experts named 25 tropical storms in the 2005 season with wind speeds of more than 39 miles per hour. That made last year’s hurricane season the worst on record, breaking the previous record of 21 named storms in 1933.
The 2005 storms also set records for insurance losses, generating three million insurance claims and causing $46 billion in insured losses, according to the National Multi Housing Council.
Insurance underwriters afraid of hurricanes now hesitate to do business along the entire Gulf Coast, from Texas to Florida, and much of the Atlantic Coast. Insurance underwriters have expanded this “catastrophic risk area” to include almost all of Florida and Houston, even though Houston is an hour’s drive from the coast.
California is another catastrophic risk area, because of the potential for earthquakes. The central business districts of New York City and Chicago also fall in this category because of the risk of terrorist attacks.
Making matters worse for apartment owners, insurance companies are increasingly likely to exclude certain types of risk, potentially leaving large gaps in a property’s coverage that must be filled in other ways. “Often when we have an insurance policy now, there will be four or five insurance companies listed,” said Caitlin Landrus, vice president of asset management for Enterprise Community Investment, Inc.
Ratings companies like AM Best, Standard & Poor’s, and Moody’s Investors Service are also threatening to downgrade the rating of insurance companies that have in their portfolios too high a proportion of properties at risk of catastrophic losses.
Most insurance policies for apartment properties include several layers of coverage. The first, or primary, layer covers losses up to a certain, set amount—say, a third of the valuation of the property, not including the land. The middle layer covers losses that are in excess of the amount covered by the primary layer of insurance and the probable maximum loss (PML) at a property. The PML is an estimate of what insurance underwriters believe the maximum financial damage to a property will be from a given disaster. The top layer covers damages between the PML and the replacement cost of the property, not including the cost of land.
After Hurricane Katrina, the insurers that covered the middle layer were hit hardest, Franco said. Many companies have simply walked away from the business. For example, Allstate has stopped writing policies that cover earthquake losses, according to the Insurance Journal, a national industry publication.
Developers find solutions
Insurance companies based in places like London and Bermuda have become increasingly important because they may be willing to increase their exposure. Trammell Crow Residential recently traveled to London to find an insurance company to cover the PML risk for its portfolio of roughly 8,000 properties, which includes a growing amount of affordable housing.
The Salvation Army, which also owns and manages a large portfolio of affordable housing, used another strategy and insured some of the risk for its properties from its own balance sheet. Some large housing authorities have also tried this strategy.
However, many smaller developers don’t have the money to take trips to London, much less insure themselves from their own balance sheets. Also, developers that use low-income housing tax credits usually can only buy insurance from companies with top ratings because of the rules laid down in their tax credit partnership agreements.
To find the best coverage, experts stress the importance of face-to-face meetings with insurance underwriters.
Owners in all parts of the country should also carefully examine their PML estimates before presenting them to an insurance broker. Make sure your PML data is clear, accurate and up-to-date. If an insurance company distrusts the valuations in a PML, the company might demand a margin clause that limits the amount the insurance will pay.
Also, if the buildings in your portfolio are especially well-constructed, be sure to document that. Features like hurricane windows, shutters, and tie-down roofs can significantly lower a project’s PML, leading to lower premiums.
Insurers now look very skeptically at the PML estimates they get from owners because these calculations proved to be so wildly off-base for many properties hit by Katrina. Many underwriters use Risk Management Solutions 6.0, a computer program, to help compute PMLs. The new version of this program was released this summer. The improved method of figuring the PML number has caused the PML amount to rise between 50 percent and 100 percent, according to experts like Franco.
Also, it’s important to start the process early, especially if your current insurance company is scaling back or canceling its coverage. Affordable housing developers should compile a photo album of their properties, Landrus said, in case the underwriters have a prejudice against affordable housing.
Looking toward the future, the price of insurance will probably keep rising until the 2006 hurricane season is finally over in November. When that happens, insurance companies will take stock of the year’s storms and adjust their business plans for the whole country accordingly. If there are no major catastrophes, prices may plateau. Insurance underwriters also will watch the resolution of court cases on the insurance claims from Katrina with concern.
Unfortunately, the outlook for 2006 may not offer too much relief, with experts forecasting 13 named storms and five hurricanes.