In Part 1 of this two-part series, Bilzin Sumberg’s Phillip Sosnow and Marsh Managing Director Michael Landa discuss the substantial changes taking place in real estate insurance markets, the effects on commercial real estate owners and developers, and how the latter can better navigate the changing market.
SOSNOW: Hello, everybody. I'm Phil Sosnow, a Partner in Bilzin Sumberg’s Real Estate Group. I'm excited to welcome you to a very timely discussion on Florida's real estate insurance market. As is now well documented and keenly felt by both homeowners and commercial property owners alike. Insurance premiums have increased markedly over the past three years in Florida and in many other parts of the country.
In fact, some insurers have pulled out of states with high levels of exposure to climate related disasters such as California, Texas, and Florida, the three most populous states in the country. Exacerbating this phenomenon, inflation and high interest rates have only heightened costs and increased volatility in insurance markets.
In light of the significant changes being experienced by such a crucial component of the real estate market, I'm sitting down today with Michael Landa, Managing Director of Marsh, one of the world's leading insurance brokers and risk advisors, with offices in more than 130 countries. Michael is a decades long veteran of the insurance industry, with plenty of insights on what forces are coming together to create the conditions we see on the ground for real estate development, real estate finance, and the housing market in Florida and in different parts of the country.
We'll first cover the current insurance market conditions generally, and then delve into insurance carrier directions and responses. And finally, some of the actions that insured individuals and businesses can take to better navigate the evolving market.
Michael, thank you for joining me. Can you please provide us with a brief synopsis of the current insurance market conditions?
LANDA: Thanks, Phil, and thanks for having me. Looking at it from a macro perspective, we've had a couple of factors that have really been driving the insurance premiums over the last 12 to 24 months. The extreme frequency of storms that we've had, the severity of storms. So climate change is a major issue right now.
What was a 50 billion dollar average year in the U.S. is now turning into excess of 100 billion dollar a year. So that's a big driver right now. Just looking at Ian, that I think set records for the deadliest storm since the 1930s, that's something that's just sort of becoming more of the norm than not going forward.
So that's a concern and climate change is driving it. Interest rates, notwithstanding the real estate market and the impact it's had there, it's having a dramatic effect on the insurance industry because a lot of the reinsurers who are the insurance companies that backstop the insurance companies, they're buying fixed rate, short term, government insured, fixed securities.
So that's taking capacity out of the market because the rates right now, where they're getting five and five and a half percent on their money, we've lost 16 percent of reinsurance capacity in '22, and yet premiums have gone up because of that close to 40 plus percent.
So that's the second factor, interest rates. Thirdly, you've got inflation and inflation, although we had some good news yesterday and it is tempering, it's still a factor. So the average insurance companies will come to you and say, okay, you've got a hundred million dollar building or portfolio to replace, that it's going to cost 120 million.
So now you've just got a 20 percent increase, just if things stay the same in your premium, then add that 40 percent rate factor and you've had a really tough year. We don't think it's going to be as dramatic on a go-forward basis, seeing where inflation and rates seem to follow. But right now, we're not seeing any reductions, so we've got to plan ahead for where we're at.
That's sort of the high level synopsis of what's going on right now in terms of the state of the market.
SOSNOW: How have the some of the insurance carriers responded?
LANDA: Right now what they're doing is they're focusing a lot on data analytics. They're getting down into specific underwriting data because right now they can't afford to make any mistakes.
The threshold for error is very thin right now. So what they're doing is they're focusing on, data analytics; as I mentioned, they're focusing on the inflation issue, which we discussed because they want to make sure whatever rates they're charging, they're getting the appropriate rate for the right replacement costs.
And if the replacement cost is not correct, then basically they're getting too little premium for what they're insuring.
There's a lot of peer review going on right now. They're talking a lot of the ability for the underwriters to use their leeway to deviate from premiums. They're trying to keep it very tight.
And then they're very focused on loss mitigation efforts. It's the water issues right now, they've got water filtration issues, they've got water technology issues, they've got roof structure issues. They're basically focusing on how to make underwriting results better on a go-forward basis.
SOSNOW: Interesting. Given the insurance carriers’ response to the market conditions, can we discuss some of the mitigating actions insureds can take?
LANDA: One of the proactive areas you can really start with as an owner, developer, is to get your appraisals done up front instead of waiting for the insurance companies to tell you what the replacement cost should be.
LANDA: So that same example, the insurance company comes back and says, yes, your $100 million portfolio last year is now $120 million in replacement cost value. Well, here it is. I've got data that shows me I've got an appraisal that says it's only going to cost a hundred million dollars. Get out in front of it. You've just saved yourself 20 percent on that. So that's meaningful if you can get out and be, proactive. Take into account some of the loss mitigation that they're suggesting. If it's economically feasible, do it. If it isn't, obviously you can't, but you've got to look at that return on investment. It's going to help you. Not just maintain the value of the property, but also help you with some of your insurance negotiations with your brokers.
LANDA: Lender covenants. Lender covenants are important because loan docs typically will have full replacement costs in there. What you need to do is you need to work with your broker, and if they're not providing it, they should.
LANDA: The risk models will basically do the data analytics. They'll show you what your probable maximum loss will be on your building or portfolio. With that data in hand, you can go to the lender and their insurance consultants and explain to them, again, I don't need to insure that full hundred million dollars.
LANDA: Maybe my 1 in 1, 000 year event is only $30 million or $40 million. The windstorm that you have to buy, the windstorm insurance, that load of insurance is probably 70 percent of your overall premium. The more you can take out and feel good about your risk factor is important. So that's another thing that you can do and also explaining to the lenders, and you wouldn't be the first one to do it, would be what is market reasonable and what is market available, and the two don't necessarily coincide.
LANDA: So even though we've got capacity, it doesn't mean that we should have to purchase it. Those are kind of the factors as far as that's concerned. Review your portfolio and your acquisition criteria. Not to suggest that insurance should drive what you buy or what you sell, but the more spread of risk you have, the more competitive you'll be in the marketplace. And that kind of dovetails into if you're a residential owner, meaning multifamily, it's very challenging to put through those increases because you're limited on how much you can push rents. As far as your commercial portfolio, you have CAM charges, which is where the insurance goes to. A lot of those CAM charges will have caps on it in many cases in your leases. Not suggesting you can go back retroactively, but what you can do is you can take some of those caps off or mitigate some of those caps so that you have the ability to push through some of those premiums.
LANDA: The other thing is try to de-commoditize your portfolio. Have your broker give you access to the carriers. Explain why your portfolio and your management is better than someone else. And the other thing is, reinsurance treaties, which is really, again, the backstop. They renew in January. Typically, they're done in 30, 60 days. Hurricane season typically starts the end of June. Optimally, you want to have your insurance renewal program sometime in the early to mid-spring because there's still fresh capacity out there.
LANDA: Rates are certain. Carriers want certainty. So you'll probably have a much better result and you're pre hurricane season and you've locked in your rates for another year. And then lastly, on that point is have your broker get out early, approach all the domestic and global carriers, but make sure when they go out to those global carriers, whether they're in London, Asian, Swiss, that those brokers have presence in those local markets. Because if they don't, capacity is at a premium right now, and those frictional costs that you may have to pay to access those markets through a third party broker because your broker doesn't have a presence there could also affect your premium. So these are just some areas that you can hopefully mitigate some of the exposure.
SOSNOW: Michael, thank you very much for your insightful observations. You've done a great job in elucidating what's going on in the insurance industry, and considerations that should be top of mind for individuals and property owners in real estate transactions, particularly in Florida.
To our audience, thank you for tuning in. We look forward to bringing you more informative and timely resources related to real estate development and investment in Florida and beyond.