Extreme Weather’s Influence on Multifamily Insurance Costs
Premiums are spiking this year. Experts weigh in on best practices for mitigating the increases.
“For those in hotbeds of catastrophic perils, it’s going to be a rough year.” That’s how Chip Stuart, the North American practice leader for Hub Real Estate Specialties, summed up what’s ahead for property risk management in 2023.
Hub predicts that insurance premiums for the multifamily sector will spike 20 percent on average this year–and as much as 200 percent in high-hazard zones, providing a major challenge to investors, developers and owners. “You want to be below that average,” he noted. “You want to show your underwriters that you’re best-in-class.” And, he added, lenders are aware of the trends.
There are ways to meet the expectations of insurers and, by extension, financial institutions. But those strategies are tied closely to the changing dynamic between climate risk and insurance. One key point is that insurance rates aren’t going up simply because of the increase in natural catastrophes. Even though well-documented supply-chain issues seem at last to be subsiding, they’re still wreaking havoc on the cost of construction materials. The same can be said about the inflationary environment and the threat of a recession.
“Premium increases are being 100 percent credited to catastrophes,” according to Jimmy Clark, executive director of Gallagher’s Southeast real estate and hospitality practice. “But a large percentage of the increases that we’re seeing is due to building costs.”
Wind, rain and fire are the most obvious of climate related risks, but residents on fault-line locations such as California (as well as a number inland) must grapple with earthquake risks. As the Los Angeles-based Stuart observes, in the absence of smaller earthquakes—those measuring less than 4 on the Richter Scale—the threat of a large catastrophic event rises.
There’s a case to be made for the link between climate change and weather-related catastrophes, but it can be a hard sell. “It’s a complex task to disentangle the natural variations in extreme weather from the effects of climate change,” noted John Scott, head of sustainability risk for Zurich Insurance Group, in a paper published in mid-2022. “While some climate change impacts are already obvious, such as retreating glaciers and sea level rise from melting land ice, the impact on today’s weather is harder to interpret.”
The Brookings Institute took a more concrete stance in a September 2022 blog by Sanjay Patnaik. Pointing out that climate-related damages in the US totaled $95 billion in 2020 alone, he wrote: “Whether you live inland or on the coast, in a small town or a big city, nearly every community, government, company and person will be exposed to some level of risk from climate change.”
He goes on to indicate that insurance costs are rising for families living in risk-prone areas, and “Investors and regulators are putting pressure on companies to disclose their exposure to climate risks.”
Picking and choosing
“This is a complex topic with a lot of moving parts,” said Chip Watts, president of Watts Realty Co. in Birmingham, Ala. But the crux of the issue comes down to margins. Without that incentive, experts say, insurance carriers won’t provide coverage. As a result, many carriers are exiting those states where the risks are in inverse proportion to the potential rewards. Nine carriers exited Florida last year and similar scenarios unfolded in Louisiana and California.
“When coverage is available, it will be significantly less than what is needed to adequately protect the property owner, or board of directors, in the event of a lawsuit,” states Hub’s 2023 Real Estate Outlook.
While the number of private carriers might be dwindling, certain states offer what Clark calls “insurers of last resort,” such as Florida’s Citizens Property Insurance Corp. Chip Watts, president of Watts Realty Co., offers an object lesson on the pain of rising costs. The replacement value of a property his firm built five years ago has risen from $12 million to $18 million. The deductible for wind damage is 2 percent of that value.
“If it’s going to cost me $280,000 to put a new roof on, and my deductible is now $360,000, I’m essentially self-insured on my property,” he said. “It would take a major catastrophe for insurance to cover any wind damage to the property.”
Salt Lake City-based developer Woodbury Corp. has run into similar issues. A $50 million construction contract negotiated just two years ago carries a $70 million replacement cost today, reported O. Randall Woodbury, the company’s vice chairman. “That’s a huge gap,” he said. Due to various delays, the contractor couldn’t complete the project by the end of the builder’s risk policy period.
“We couldn’t roll the project into our permanent policy prior to receiving a Certificate of Occupancy,” Woodbury recounted. Ultimately, they negotiated an extension, “but it was very costly.” And that, he adds, is a battle yet to be fought with the contractor.
Investors and developers who find themselves without a carrier do have choices. Stuart points to the non-admitted carrier market, although it is clearly a cloudier option and “very different from the retail markets.” Non-admitted carriers come with major caveats. They are not recognized by the state and need not play by state regulatory rules. Their rates can deviate up or down “at will.” Customers taking the option might risk further taxation and an audit by the state.
But for those with a sufficient tolerance for risk, there are benefits to be had. Many states have a set of less stringent guidelines for non-admitted insurers, as insureon.com states. With a little more regulatory wiggle room, non-admitted carriers will go places that name-brand insurers find too risky. For example, they might cover assets that are “located along the Gulf Coast, or in an area known for brush fires, [where] it may be difficult to find an admitted insurer,” Stuart noted.
Experts emphasize that due diligence is essential in the selection of any partner. As Clark advised, “You need to look at the financial rating of the insurance carrier, no matter if it’s admitted or non-admitted.” In addition, certain states have a guaranteed fund. The California Guaranteed Insurance Association (CGIA), protects the insured if a carrier goes under, but only if the carrier is one of the state’s admitted insurers.
Protection against bankruptcy is one of the roles of a reinsurance company. By taking on a portion of the primary insurer’s liability–essentially insuring the insurer–reinsurers tamp down the extreme payouts of a catastrophic event. (Swiss Re pins the total 2022 insurance losses from natural catastrophes at $115 billion. )
But, as Clark noted, reinsurers have less to sell these days since they’re funded by insurance-linked securities, and there’s less of that investment money from third parties coming in. “The reinsurance they do have to sell is at a much higher price,” he said. Rather than shouldering more of the insurance risk, they’re asking the prime carriers to hold more of it on their books.
How can multifamily investors, developers and owners show potential insurers and lenders that they are best in class? Even though insurance is too often an afterthought, protection against natural forces of all types should start well before shovel meets dirt.
A logical first step is to assess the local market risk. “Regional exposures are one of the reasons we choose not to play on the coast,” says Woodbury. But with more than 180 properties owned and managed in 16 states, the company’s portfolio inevitably includes assets exposed to extreme weather risks, such as properties in Tornado Alley.
Keeping your insurance broker close at hand is also prudent. “It’s all about data,” Watts observed. “That’s what everyone is basing their decisions on.” While perhaps not privy to the long-range data that’s available to the decisionmakers, the agent at the table will still provide guidance as to what the data says. And if that agent is unwilling to meet you on site, Watts advised, “You probably need to find another agent.”
In securing insurance for new builds, construction materials are a key component and should be appropriate to the area. A building shouldn’t use unreinforced masonry on a fault line or wood framing in a vulnerable location designated as a Tier One wind zone.
Woodbury reports having no issues in obtaining insurance for a steel-and-concrete structure the firm has in the works. But he adds that if you have a $40 million budget, “The risk of loss is deemed to be less if the project happens to be made up of four $10 million structures with adequate fire separation between them, versus one large structure. They’re easier to insure.”
Driven by data
Being armed with much of the data available to insurers is also vital for informed investment and development decisions. “The carriers are looking at more data than I’ve ever seen,” says Clark. Even the types of roofing nails you’re using “could change your rate.” Risk-mapping information is available from a number of sources, such as the Federal Emergency Management Agency, and the National Association of Realtors (NAR) provides toolkits for flood and fire. Watts cites the International Building Code as a resource for guidance on hardening an asset against weather events.
Existing buildings present different challenges. As Woodbury points out, “There are things that you can do, but they’re major.” Replacing a roof that could be destroyed by catastrophic wind damage, or is constructed of combustible materials, requires a major investment. Addressing other issues requires reaching for lower-hanging fruit. “If you have trees growing against the building” in a fire-prone area, “that’s an easy one to tackle,” Woodbury noted.
Transparency with a potential candidate is also advisable. “As the insured, you want to provide them with as much information as you can–and it has to be the best information,” Stuart said. “You don’t want them to find that the wiring came from 1970.”
Clearly, the insurance market today is not that of 1970. A rise in natural catastrophes coupled with changing economics and construction dynamics are reshaping our relationships with our insurance carriers. But, as Hub’s outlook states: “Real estate owners and operators who understand their risks and embrace creative market solutions will have better coverage options at lower costs.”