Techniques for commercial real estate pros to manage insurance costs
Rising insurance costs have created a burden for everyone in the CRE value chain, but some existing tools can help.
Higher interest rates are a problem, but not the only one facing CRE professionals. Moody’s Investor Service has noted that insurance costs were up 73% between 2017 and 2022. Combined with other increases, like taxes and utilities, the challenge of keeping a reasonable NOI can be formidable.
Everything counts, so anything you can do to control and mitigate each part is important. Moody’s Analytics offered some ideas earlier in January for insurance. It’s actually a three-part approach.
First is to have “early and nuanced negotiations.” Owners and lenders understand the statistical (stochastic catastrophe, or cat) models insurers use to calculate their premiums. “This allows for a more nuanced discussion on the expected loss for a particular asset under different extremes, alongside the cost of different amounts of insurance coverage and the consideration of opting for a higher deductible or lower coverage limit to reduce the premium,” they wrote. For example, the buyer and lender might agree on coverage for modeled loss cost instead of full replacement cost for a highly unlikely event. Using cat models isn’t new, but given the rise of premiums, it’s become more important.
Next comes alternative ways of transferring risk. One is using parametric insurance that’s triggered by a threshold condition like height of storm surge or wind speed. Payouts are usually faster, payout isn’t restricted to a particular type of loss, and underwriters can have greater certainty that might make them more willing to cover a high-risk area. It might be used in conjunction with traditional coverage with a smaller payout that might cover most or all of a deductible.
Insurance-linked securities like catastrophe bonds can use capital markets to take up part of the risk. Captives are corporate structures, usually only good for very large companies, that become a form of self-insurance with flexibility in terms and also providing tax benefits.
The third approach is to incentivize resilience. The company can work with insurers to understand what factors — building age, type of roof, flood walls, equipment locations, power backup, and more — play into the setting of premiums. That offers two opportunities to property owners. One, by making sure the resilience investments they’ve already made are properly acknowledged, and two, using the information to implement additional resilience investments that might offer the best paybacks on reduced premiums. “There is also an opportunity for insurers to leverage their detailed understanding of asset characteristics to get involved in the capital stack,” they write. “For example, the National Energy Improvement Fund is a lender and insurer, helping to finance energy efficiency and resilience retrofits for both commercial and residential buildings.”