Insurance is an issue that property owners and developers hate to talk about, but it is an area that can cause a costly headache if it isn't dealt with correctly. And, its inherent volatility doesn't make it any easier. The rash of killer storms in 2005 sent insurance costs skyrocketing, especially in the Southeast. In some areas, such as sections of Florida, it became nearly impossible to secure insurance at any price. Three relatively calm years since then, however, have eased those pricing pressures.
Today, what buzz there is around insurance surrounds a new technique many owners are considering when insuring new projects. Traditionally, in a construction project, each party — the owner, the general contractor and various subcontractors — secures separate insurance coverage to cover worker's compensation and general liability claims. The arrangement sounds good, but in practice contractors or subcontractors sometimes failed to line up proper insurance. As a result, when incidents did occur, the project owners were held liable and claims were levied against their policies.
Now, more owners are instead opting to take full control of insuring projects. They are putting in place what are called owner control insurance programs (OCIPs) under which a developer subsidizes a general loss fund to insure all parties. Under an OCIP, a developer insures against a contractor or subcontractor not having the proper or adequate amount of coverage.
Under an OCIP, the project owners' premiums help subsidize a loss fund, from which any monies remaining after all claims are paid out revert to them, explains Bob Pote, underwriting manager for specialty property at the Philadelphia Insurance Company. The upside for insurers, he says, is that OCIPs allow them to go after the party responsible for the loss. “There is no squabbling about who is at fault,” Pote says. “The incentive is for the contractor and the developer to work together to minimize the liability to the insurer,” says Yaromir Steiner, CEO of Steiner + Associates. Half of Steiner + Associates five-million-square-foot portfolio is covered by OCIPs. The Columbus, Ohio-based developer began using OCIPs in 2004 with the construction of its Kansas City, Mo., 550,000-square-foot town center Zona Rosa. Sonia Arora, controller for Steiner, adds that OCIPs typically make the most sense for developments that are at least 750,000 square feet or larger because of the number of players involved.
Meanwhile, Columbia, S.C.-based Edens & Avant, a developer of neighborhood shopping centers along the East Coast, plans to put in place its first OCIP this year. The firm has a growing roster of construction projects in its pipeline that average $75 million. “We have a couple of projects coming out of the ground over the next few years that are prime candidates,” says Jason Tompkins, CFO of Edens & Avant.
In general, OCIPs make the most sense on large-scale projects because of the increased chance of owners getting money back from the fund, Arora says. There are always likely to be some claims, but they typically amount to less than what an owner is putting into an overall fund.
“If there are very few claims, [the monies remaining] in the loss fund would revert to the project owner and help offset their expenses,” says Arora. She adds, “They [OCIPs] can be more expensive [for the insurer] if the loss fund is depleted and the claims keep coming.”
The cost of OCIPs as a percentage of the project total ranges between 0.6 percent to 1.2 percent of the total cost and would have to take into account factors, including the projects' cost, size and location.
Pote concludes, from a developers' standpoint, OCIPs are cleaner and neater. “They [OCIPs] are pretty much accepted as the way to go,” says Pote.
He adds from the insurer's perspective, for example, OCIPs provide Philadelphia Insurance Co. with additional opportunities to provide coverage for a category of projects it seeks to insure.
NAI Realvest, a network of more than 300 commercial real estate firms providing services, including consulting, due diligence and investment recognizes the advantages of the self-insurance program; however, an executive expresses caution. “The concept makes sense. The question is who is the entity that controls the pool and how solvent they are,” says Mez Birdie, director of retail services for NAI Realvest. “The concept only works if the monies are available.”
Birdie warned, if the insurance carrier's rating is a B, the risk factor increases, reflecting the insurer's ability to pay out any claims. The insurance industry's ratings agency A.M. Best rates carriers in categories ranging from AAA, which is superior, followed by AA, A and so forth down to C. According to Birdie, you don't want an insurance company with a rating below an A.
He adds, an additional benefit of an OCIP is it replaces the need for the general contractor to insure their bond on a project and it can also help lower the cost of the bond. There is no standard cost for a bond; they vary widely depending upon a number of factors, including the type of center, size and its geographic location.
This year, the Bala Cynwyd, Pa.-based Philadelphia Insurance Co. expects to write $8 million in coverage of retail shopping centers, up from $7 million in 2007. Since 2005, it has increased its underwriting of retail shopping centers by an average of 15 percent. However, it has become increasingly challenging in a hotly contested environment. While its policy totals have risen steadily from $4.4 million in 2005, before Hurricanes Rita and Katrina, Pote says, Philadelphia Insurance Co. is writing policies in 2008 at rates less than it has in the past few years.
Premiums fell in 2007 to around $1 per square foot, Birdie says, down from more than $3 per square foot in 2006 after Hurricanes Rita and Katrina. Since then, business has been more competitive with insurers more willing to underwrite policies on shopping centers. To keep its renewal business, Pote says, in 2008 Philadelphia Insurance Co. is writing policies 25 percent less than it was last year.
“In general, I cannot continue to write at the prices we have been” says Pote. “It [the 25 percent reduction] is not a good formula for being profitable. I'm going to have to walk away from some business.”
For example, since 2003, Edens & Avant's property insurance costs have remained relatively flat. Meanwhile, it has negotiated 20 percent reductions in its general liability coverage costs from 2007 to 2008. Last year, it spent close to $5 million for coverage for its portfolio consisting of 130 centers in 14 states along the East Coast. Prior to Hurricane Katrina, it spent $3 million on coverage; however, its portfolio has grown to 15.5 million square feet with 20 percent of its footprint in Florida.
Despite its significant exposure in the Sunshine State, which is prone to flood, wind and storm damage, Tompkins says, it has been able to keep its costs in line by aligning itself with carriers that understand its business strategy. He attributes the static costs to routinely scheduled meetings with the carrier to discuss their strategic growth in Florida. For example, if Edens & Avant is outlining its acquisition plans within the state, the developer's in-house insurance manager, risk manager and a consultant outline for Liberty Mutual its due diligence and planned improvements at the centers to mitigate losses from any known and/or identifiable risks.
“We know the executives there,” says Tompkins. “They have a capacity for our growth and they have been very competitive in terms of premiums.”
Still, even though insurance costs have fallen from the immediate post-Katrina levels, they remain higher than they were prior to 2005. Before the storms, premiums were as low as $0.20 per square foot, according to Birdie.
He predicts insurance rates will hover around 2007 prices throughout this year, barring any catastrophic natural disasters in the United States.
However, Birdie adds, the rates for retail properties on the coasts, which have heightened risks of earthquakes and hurricanes, could be higher.
With the potential threats mega-malls and destination and theme centers face, Philadelphia Insurance Co. has defined its niche as an insurer of neighborhood, community and regional shopping centers. Noting the increased exposure due to falls from amusement rides, fires in restaurant kitchens and slips on waste in food courts, it finds those categories of retail projects are no longer acceptable.
“We don't want to write centers with more than a 25 percent restaurant exposure. We understand food courts and a restaurant venue will be there, but, once you get beyond 25 percent, it's more exposure than we are willing to risk,” Pote says.