Doron Valero considers himself fortunate.
The president and chief operating officer of Equity One Inc. guesses property insurance on the REIT's shopping center portfolio will rise only 55 percent this year.
That may not sound lucky, but Valero hears some developers may face 100 percent to 150 percent increases. “We are fortunate because we have a large policy, so we got a reasonable deal,” he says.
Valero is especially fortunate about insurance costs because most of his firm's 195 properties are in the eye of the storm: In the Southeast, with concentrations in Florida, Louisiana and other hurricane-prone-states.
“If you want to be along the coast, you have to be willing to pay the price,” he says.
As the insurance industry sorts out its losses from the disastrous hurricane season of 2005, one thing is certain: Shopping center owners that have properties along shorelines or in flood zones will pay considerably more — if they can get it. The good news for others in areas relatively safe from hurricanes and earthquakes: Don't expect much of an adjustment in rates
“In places such as Iowa, which historically has had low insurance rates, there won't be much of a change for owners,” says Bill Wilson, an associate vice president of the Alexandria, Va.-based Independent Insurance Agents & Brokers of America. Rates should be fairly stable.
But, in the coastal areas, watch out. And it's not just the usual Southern subjects — Florida, Mississippi, North Carolina. “We had major flooding last year in New Hampshire,” says Wilson.
Robert Odell, president and chief operating officer of LyonsOdell, a Radnor, Pa., independent property/casualty insurance agency and subsidiary of the Lyons Co. says to expect rising rates for such coastal areas as Long Island. The particular problem area will be the fast-growing state of Florida, he adds. “In the past, insurers may have asked what Florida county are you in; now they are redefining the whole state,” he says.
Hard to get
“This is the most complex market I have seen in 20-plus years,” says Bob Howe, a managing director at insurer Marsh Inc. in New York and head of its property practice. “That's because we are seeing clients with catastrophe exposure, be it earthquake or windstorm, really having challenges procuring insurance. Underwriters have become very conservative.”
As a result there is a supply crunch of availability in earthquake areas such as California and the hurricane regions stretching from the Gulf of Mexico up the East Coast, Howe adds. “In the past five weeks, we have seen a dramatic uptick in pricing for catastrophe-exposed properties and property insurance supply is way down,” says Howe. “It has become much more challenging to put together our big property programs.”
Property insurance policies usually exclude coverage for flood damage, which can be obtained from the federal government's National Flood Insurance Program.
Flood insurance is available at federally subsidized rates to residents of communities that have adopted regulations for development in floodplain areas. This is particularly important at the time of property financing because if a lender determines the location of the property sits within a floodplain, and the community participates in the NFIP, the borrower is then notified that flood insurance is mandatory before receiving a loan.
The current limits are $500,000 for the structure and $500,000 for the contents, which may not be enough to protect many businesses, explains Loretta Worters, vice president of the Insurance Information Institute in New York. “Businesses with greater assets will need more coverage than the maximum limit provided by the NFIP program, and may be eligible to purchase additional coverage through an Excess Flood Insurance Policy. The problem is, because these properties are located in such high-risk areas, coverage is getting more difficult to come by and is becoming more costly.”
Some changes in the NFIP may be ahead, as a bill was introduced at the end of last year into the House Committee on Financial Services that may be a boost in the amount of coverage for flood insurance, says Wilson. “You will be able to buy more insurance coverage. We don't know how much, but it will go up. For commercial properties they are looking to go from $500,000 to $670,000.”
Although the 2005 hurricane season has been over for almost six months, the market is still in a state of flux, so rates haven't really peaked.
The property and casualty part of the insurance industry had not made an underwriting profit on business since 1978, according to Wilson. “The industry finally made a profit in 2004, but was wiped out many times over in 2005.”
However, after profitable 2004, rates began to decline, premiums started to go down. “When that happens, the industry actually hits a trough where rate declines pick up speed due to competition,” according to Wilson.
While the catastrophes of 2005 put an end to that pattern real quick, it has taken the industry some time to reverse course and actually start raising its rates, especially in response to reinsurance.
The industry will see a push for higher rates, especially from reinsurers, says Wilson. “So many companies had to dip into their reinsurance that there is a lot of pressure on the business. The cost of insuring a book of business is going to go up substantially.”
Who do you think pays?
All that cost, of course, will be passed down to the consumer.
Philadelphia Insurance Cos., whose parent is publicly-traded Philadelphia Consolidated Holding Corp. of Bala Cynwid, Pa., specializes in commercial insurance products including property insurance for shopping centers. It expects prices to rise, if for no other reason than reinsurance costs going up.
The market took some hits from the 2004 hurricane season, but reinsurance pricing didn't move that dramatically, explains Neal Schmidt, a vice president of Philadelphia's commercial lines division, and the reason for that break was that the basic actuarial modeling didn't alter much after 2004. That salubrious phenomenon is over.
“What drives reinsurance pricing is the catastrophic modeling process, which is an actuarial model that predicts expected losses,” says Schmidt. “After 2004-2005, the companies that do the modeling have changed the assumptions for risk and increased the factors for damageability.”
The NFIP was created in 1968 to achieve three goals: provide property flood insurance coverage that was not available through private carriers; reduce taxpayer-financed assistance for property owners affected by flooding; and reduce the total amount of damage through floodplain management.
The hurricanes of 2005, in particular Katrina, blew apart the NFIP and its goals. According to one congressional study, the insured flood damage caused by hurricanes last year exceeded $24 billion, a figure 10 times the amount of premium income the NFIP generated in all of 2005. As a result the NFIP was technically bankrupt and had to be bailed out by Congress, which kicked in $20 billion in emergency supplemental aid. Other issues lingered as well.
For example, a number of class-action lawsuits involving the cause of damage appeared. Wind damage is generally covered in property insurance, but flood damage isn't. A number of properties in the Gulf Coast area were damaged by the wind pushing coastal waters in-land, thus flooding occurred. The lawsuits want wind-induced water surges to be covered under property insurance. How this will end up remains to be seen but Wilson believes the lawsuits are unfounded.
According to the actual language of the insurance policies, the definition of flooding is any overflow of water outside normal boundaries. The premise of many of the lawsuits that have been spurred by the hurricane is over whether or not the flooding was the result of wind-driven water. The argument: Policies cover wind-driven damage therefore they should cover wind-driven water damage. According to Wilson, the wording of the policy specifically excluded that idea; prior court cases have upheld that language. Mississippi is the main state where this is being litigated.
The Federal Emergency Management Agency, which oversees NFIP, will be looking to redraw flood maps and a number of shopping centers could find themselves suddenly in a redrawn floodplain. “The floodplain maps have been woefully inadequate for the past 10 to 15 years. Particular areas of the Gulf Coast vulnerable to flooding, as an example, were not included in maps years ago,” says Worters.
If in a floodplain, flood insurance will be mandatory for owners. “Requiring business owners to carry flood insurance is a good thing,” says Worters. “Many businesses would rather invest the money back into the business than buy coverage. Yet, it is a crucial part of planning your business's success, maybe even its survival.”
A spokesperson from FEMA says the agency first became concerned about the inadequacy of the flood plain maps in 2004, after Hurricane Ivan caused flooding in areas that had never been touched.
FEMA issued “recovery maps.” In 2005, the agency expanded that concept and established “advisory-based” flood elevations. So far, it has put out new advisory documents for the three coastal counties in Mississippi and the coast counties in Louisiana. It is waiting for the Army Corp of Engineers to fully report on the strength of the levees in New Orleans before putting out documents for the city.
For most areas, this is the first flood-map update since the early 1980s.
“Land use has changed in a lot of those areas — there's more tourism, there's big boxes and casinos, which are eating up a lot of watershed areas,” the FEMA spokesperson says. In addition, the maps were drawn in a period where there was little hurricane activity in the Gulf Coast.
“Since then, a number of monster storms gave us new data on how high water can actually push,” the spokesperson says.
Remember to adjust
A final issue exposed by the hurricanes is the level of under-coverage plaguing commercial property. The problem is that owners buy policies when they first take control of a building, but then don't adjust those plans as the value of the property appreciates. For example, a center acquired for $10 million in 2001 may be worth $15 million today. An owner may have a 100 percent policy on the building, but may only be paying on the $10 million value. If the property is damaged, insurance companies are going to argue that you're only insured for 66 percent of the building's value.
A 2005 Marshall & Swift study reported 75 percent of commercial buildings are undervalued by an average of 40 percent.
Wilson argues it's a difficult problem to address. “When you have a disaster and you have a shortage of building materials and labor, it drives up cost.
There is no way, in the case of a disaster, for an owner to have a building adequately covered for damages without over-insuring, he says.
“One of the policy suggestions we would like to see would be a catastrophe provision so if there is an official catastrophe, there would be an override of, for example, 25 percent, if construction prices were driven up. If your property is insured for $2 million, but it is now worth $4 million and it is destroyed, it's too late to do anything.”