Managing Risk and Rising Insurance Premiums in Commercial Real Estate

May 02, 2024

Managing Risk and Rising Insurance Premiums in Commercial Real Estate

Since 2017, commercial real estate insurance costs have risen an average of 7.5%, according to the Counselors of Real Estate, hosts of a recent discussion on how to manage rising premiums. Insurance costs as a percentage of income have more than doubled over the past five years, leading to higher operating costs and downward pressure on net operating income.

“We’ve seen a little stabilization enter the insurance market in 2023, but that’s after six or more years of disproportionately high premium increases,” says John Kempton, senior vice president with FHS Risk Management, an independent insurance and risk management company. “In some cases, premiums have increased 20% to 40%, and in places like California and Florida, we’ve seen triple digit increases.”

In 2023, insurance companies paid more than $100 billion in losses even though there wasn’t a major hurricane, Kempton says. High dollar insurance payouts are caused in part by increased construction costs and inflation.

Another issue, particularly for owners of multifamily, senior living and hospitality properties, is that the number of claims and the amounts paid for claims against casualty insurance have increased significantly.

“The main issue with the casualty side of insurance is severe jury verdicts that decide people need payouts of $10 million or $15 million even when the owners have negligible liability in the case,” Kempton says.

Solving that problem requires tort reform, Kempton says, which could take time. In the meantime, owners must adapt to a new insurance environment.

“Property owners experienced a long soft market for decades, so many owners bought lots of inexpensive coverage with low deductibles,” Kempton says. “Those days are over now. The old way of buying insurance is a relic of the past, so owners need to build new structures to manage risk.”

Solutions to Mitigate Insurance Woes

High insurance premiums, non-renewals and conditional renewals, such as those that stipulate owners must make specific property improvements, are challenges many commercial real estate owners face.

Some strategies to consider include:

  • Prepare for proper valuations. Insurance carriers are more focused on due diligence, Kempton says, so owners need to be prepared for a larger premium jump if their insurance is based on outdated values. In the past, some owners deliberately underestimated replacement costs to save money on premiums, Kempton says, but insurance companies are catching up now and are focused on value.
  • Gather data prior to a renewal. Insurance carriers rely on information from data analysis companies such as CoreLogic that may not be accurate, so owners should be ready with their own data on property values and replacement costs, Kempton says. This can be especially helpful if owners can show that replacement costs may be lower than the insurance carrier’s estimate.
  • Provide updates on property improvements. Owners who make improvements should let their insurance companies know so those changes can be incorporated into the renewal and premiums. For example, if you have a new roof on a property in Florida or California, your premiums could be substantially lower than if you have a 40-year-old roof, Kempton says.
  • Evaluate your deductible. Determine how much of a deductible you can live with and make sure you have the funds to cover it. For example, if you anticipate a maximum of $500,000 in losses, prefund that internally. Your insurance premiums would be lower, and you can avoid making multiple claims that could increase your premiums or trigger an insurance non-renewal.
  • Consider aggregate deductibles. Insurance carriers for multifamily portfolios with 2,500 to 5,000 units or more expect a certain number of claims annually and will push owners for a deductible of $250,000 per occurrence so they don’t have to pay for every claim. Owners can offer an aggregate deductible of $500,000 or $1 million annually and be responsible for losses up to that limit before asking their insurance carrier to cover additional claims with a $100,000 deductible. One benefit of this idea, says Kempton, is that insurance premiums are a fixed cost. Self-insuring allows you to rollover leftover funds to pay for losses the following year.

Whether your premiums have risen, or you’ve had losses and it’s difficult to get insurance, alternative risk transfer strategies are available such as structured programs and integrated programs, says Aiden Joo, head of alternative risk transfer for Marsh, a global insurance and risk advisor company.

Structured programs are multiyear solutions with fixed premiums for budget certainty. You’re essentially setting up your own internal insurance company to manage a portion of some risks, including even some risks that can be difficult to insure such as wildfire and floods, Joo says. One benefit is the potential to have premiums returned after three years, which can then fund premiums in subsequent years.

Integrated programs, which can include multiple lines of insurance over a multiyear period, can offer lower premiums because of shared risk with the insurance carrier, Joo says.

To overcome insurance challenges, owners can raise their deductibles, provide insurance companies with quality data about property values and risks, and determine how much risk they can cover internally.