Apartment owners are feeling the pinch of a new insurance environment that is squeezing operating budgets across the country. Property and liability insurance costs have increased 50% to 100% in the last six months, and experts predict double- and triple-digit increases could continue for at least two more years.
While the Sept. 11 terrorist attacks focused much attention on rising insurance rates, the situation was nearing a crisis level even before the tragedies. The industry needs to support federal initiatives that would provide insurance coverage for any future terrorist attacks, but such measures are only part of the solution to a long-term crisis. (For more on terrorism insurance, turn to page 32).
How serious is the problem?
Broad generalizations on insurance increases are difficult to make because rates depend on a wide variety of firm-specific factors, including prior-loss history, scope of coverage and risk of exposure to catastrophic events. However, apartment firms that renewed coverage in fourth-quarter 2001 reported that annual property and general liability costs increased dramatically, rising from rates of $150 to $250 per unit to $250 to $400 per unit.
Assuming the average unit generates $10,000 a year, insurance costs now consume 2.5% to 4% of that revenue. With future increases likely, many firms could pay as much as 8% of their revenues for insurance by 2002. Some properties report they already pay up to 12% of their revenue for property and liability umbrella coverage.
Why the sudden and dramatic increase? First, multifamily underwriters have experienced losses on claims for several years, which has resulted in almost half of these firms leaving the market entirely. At the same time, 2000 and 2001 were two of the worst years on record for catastrophic losses.
The Sept. 11 events capped off a year of losses that also included the Puget Sound earthquakes in Washington state and tropical storm Allison's soaking of Houston. Fewer underwriters and heightened losses mean remaining underwriters must increase rates and deductibles, and reduce coverage for everything from mold damage to terrorist attacks.
The insurance situation became even more challenging after the events of Sept. 11. Shortly after the attacks, the insurance industry testified before Congress that it would limit or eliminate coverage for future terrorism-related claims. The National Multi Housing Council (NMHC) and its joint legislative partner, the National Apartment Association (NAA), along with a wide range of real estate industry groups, quickly urged Congress to create a terrorism insurance mechanism. The groups also met with White House staff to emphasize that lenders will not finance newwithout adequate insurance coverage, and that the sale of existing properties would come to a halt in such a situation.
A piece of the insurance puzzle
But NMHC and NAA believe that closing the terrorism insurance gap is just one component of solving the apartment industry's insurance crunch. Even with the terrorism situation resolved, future insurance rate increases still are likely because of past losses and fewer underwriters. A key determinant of the impact this new insurance environment will have on the apartment industry is how the capitalrevise their underwriting guidelines to reflect the new insurance environment.
New realities require new thinking and new procedures, and NMHC/NAA are working to develop both. Twice in the fourth quarter of 2001, NMHC's Risk Management Roundtable brought owners and lenders together for candid discussions. In November, apartment executives and representatives of Fannie Mae and Freddie Mac discussed the need for higher deductible requirements, continued flexibility with insurance ratings requirements and alternative methods of financing large premiums.
There was a general consensus at these meetings that the scope of coverage, deductible levels and rates that typified the market as recently as 2000 have dramatically changed. Also, given the new complexity of insurance underwriting, participating parties agreed that insurance coverage will be discussed by capital providers and borrowers earlier in the loan underwriting process.
Nevertheless, it seems there are competitive advantages to be had for everyone. Apartment owners and managers that maintain low property and liability losses through smart risk management can benefit significantly through lower premiums and deductibles. Also, lenders that exhibit flexibility in applying insurance requirements will become a more competitive source of multifamily capital.
Jay Harris is vice president of property management for the National Multi Housing Council/National Apartment Association Joint Legislative Program.