As Japan continues to struggle with the aftermath of the March 11 earthquake and tsunami, U.S. property owners may want to examine whether they are sufficiently prepared for disasters of that scale.
Even the Japanese, long used to massive earthquakes, did not anticipate a 9.0 magnitude event and ended up overwhelmed by the scope of the damage. Existing safeguards against seismic activity and tsunamis proved inadequate. The cost of damages may reach nearly $300 billion, with between $14 billion and $33 billion of the rebuilding costs covered by private insurance.
The issue is particularly important today—on the heels of the recession—because as owners cut costs during the downturn, they may have left themselves under-insured. And even those that have coverage may face disputes with providers as to who is ultimately responsible for paying for damages.
Most retail property owners in the U.S. purchase standard insurance, which covers wind events and tropical storms. But insurance for catastrophic events, including floods and earthquakes, has to be bought separately and can be quite costly for centers located in high risk areas. And this is an expense on which owners may be skimping, says Linda Paul, director of risk services with RLI Corp., a specialty insurance company based in Peoria, Ill.
“I would say that in tough economic times, when a lot of retail owners are hurting and have not optimal occupancy rates, they look at insurance as a line item that they want to reduce. A number of them are leaving themselves exposed,” says Dan Kleiman, head of the real estate segment with Zurich North America, an insurance-based financial services provider.
This is particularly true for owners of smaller, private portfolios, who often have fewer financial resources and no obligations to shareholders to protect their holdings the way publicly traded REITs do, adds Mark A. Manfre, executive vice president with the Insurance Office of America, an Orlando, Fla.-based independent insurance agency. If properties are located in low risk areas, owners might see insurance costs as an unnecessary expense and opt not to purchase flood and earthquake insurance at all.
Other owners may be trying to reduce insurance costs by underestimating the replacement value of their properties, notes Alexandra Glickman, managing director and practice leader with Gallagher Real Estate & Hospitality Services, a risk financing firm. The strategy might help reduce insurance premiums, but if the owner is faced with the prospect of rebuilding, the insurance payout won’t cover the costs of building a new center, especially since in the wake of floods and earthquakes, costs of labor and materials often spike, Glickman says.
The problem with “it will never happen here” thinking, according to Paul, is that catastrophic events are often unpredictable and can happen even in areas not prone to flooding. For example, according to FEMA, between 20 percent and 25 percent of all National Flood Insurance Program (NFIP) claims.
“Flood and earthquake insurance policies do not need to be purchased for the full value of the property all the time,” Paul says. “But depending on where you are located, [purchasing some coverage] is a good idea.”
Standard insurance policies for commercial properties cover tornadoes, hail and some tropical storms. Most insurance policies are underwritten to reimburse owners for 100 percent of property’s estimated replacement cost if it is severely damaged or destroyed in the course of such natural disasters.
However, even owners who have insurance may have to fight to get claims filled. For example, after Hurricane Katrina, disputes arose over whether building damage was the result of hurricane winds or flood waters. Since those are covered by different kinds of insurance, it led to fights over who was responsible for payouts, resulting in multiple class-action lawsuits.
In another example, almost a year after its Opry Mills center in Nashville was damaged by severe flooding, Simon Property Group, the largest regional mall REIT in the U.S., hasn’t resolved a dispute with its insurance providers over more than $200 million in damages that occurred at the property.
Simon claims it purchased excess insurance policies that make it eligible to receive up to $200 million, while its insurers say the firm is entitled to only $50 million because Opry Mills lies in an area that is considered to be a high risk flood zone.
Nevertheless, Simon has pushed forward with repairing the property and recently announced plans to reopen the center in 2012.
Given the potential for insurance disputes, property owners ought to buy flood and earthquake insurance even if they feel their centers are located in low risk zones, says Paul. For example, the U.S. Geological Survey estimates that in Eastern U.S., normally considered a low risk zone for earthquake events, there is a 25 percent to 40 percent chance of a magnitude 6.0 or greater earthquake in the next 50 years.
(The likelihood of a 6.0-magnitude or greater earthquake in Northern California over the next 50 years is almost 100 percent).
“You’d like to think you are adequately insured, but you don’t know,” says Manfre. “Who would have thought that a major earthquake, a tsunami and a nuclear accident would happen in Japan?”
The costs for earthquake and flood policies vary considerably depending on whether the property is located in a high risk area, Paul notes. For low risk properties, the cost often works out to only a cent or two per $100 of property value.
Finding commercial insurers willing to underwrite properties in known flood or earthquake zones may be more challenging, but if the owner is willing to pay the price and find a solution, it’s possible, says Glickman.
The federal government offers some protection for businesses in high risk areas through the National Flood Insurance Program, but there are severe limitations that come with that coverage, notes Manfre. Property owners have to request flood insurance at least 30 days in advance of the flood to be eligible for compensation and the coverage limit for commercial properties is only $500,000. What’s more, the NFIP does not cover financial losses resulting from interruption of business or damage to structures outside the building.
Meanwhile, there is no federal insurance coverage for earthquakes, notes Kleiman. The Federal Emergency Management Agency (FEMA) provides individuals and business owners with some aid in the wake of major natural disasters, but this most often takes the form of low-interest loans, rather than direct reimbursement.
That means retail property owners would be wise to carry at least some coverage against both floods and earthquakes, says Manfre. Such policies normally come with a deductible that rises along with the likelihood of an adverse event, ranging from about 2 percent to 5 percent of the property’s replacement cost for centers located in high risk areas, according to Kleiman. (Deductibles for standard all risk insurance policies, by contrast, are usually indicated with a simple dollar amount.)
The cost and coverage offered by these policies varies widely depending on geographic area, year of construction and the property’s structural soundness, but there are ways to reduce insurance costs while making sure the center carries at least a basic level of protection.
For example, if a deductible for earthquake or flood insurance for a center is greater than the center’s owner can afford, some insurance companies offer deductible buy-back policies, which insure the deductible amount, in effect drastically reducing how much cash the owner has to pay, Paul says.
In addition, it’s possible to purchase insurance against multiple catastrophic events happening in the same year. Such coverage stacks up multiple insurance policies from different providers, protecting the property against scenarios like the one that happened in Japan, where some towns were hit by a severe earthquake, a devastating tsunami and high magnitude earthquake aftershocks that were still occurring as recently as this week.
“There is a tendency, particularly for things that are catastrophic in nature, to say ‘I am going to take my chances,’” Paul says. “And property owners either quit purchasing the policies or purchase reduced coverage. And we have seen in the past that when a catastrophe strikes, there can be a significant loss.”