Insurance costs are a painful burden for HRI Properties, a New Orleans-based firm that owns and manages apartments. Before Hurricane Katrina hit in August 2005, the company was paying $500,000 in annual property insurance premiums. Now HRI spends $2.4 million to insure 15 properties, which include 2,281 units, says David Abbenante, president of HRI Development's property management division.

“We were fortunate to find coverage,” says Abbenanate, who serves as president of the Apartment Association of Greater New Orleans. “Many people can't afford insurance, and the high costs are holding back the redevelopment of New Orleans.”

Two years after Katrina struck, insurance markets are still feeling the effects of the giant hurricane. In coastal areas from Texas to Boston, insurers have raised premiums. After witnessing the destruction in the Gulf Coast, insurers in California reexamined their risks and increased premiums 25% in earthquake zones.

In a strange twist, bad news in the coastal markets helped to reduce prices for most of the rest of the country. Uncertain how to handle risk in hurricane-prone areas, many insurers stopped providing coverage there and began competing for business in the Midwest and other regions that appeared relatively safe. That has lowered premiums in most states.

On average, the cost of insurance coverage has dropped 20% nationally since peaking at the end of 2003, says David Bradford, executive vice president of Advisen Ltd., a commercial insurance consultant in New York. “Prices should continue dropping sharply in most of the country this year,” says Bradford. “But in the Gulf Coast, property owners may not get much relief.” (See related story p. 16)

To assess how the commercial insurance system has worked in the Gulf Coast, the Rand Corp. conducted a study, interviewing 69 policyholders and lenders in August and September 2006. The findings were not encouraging. A quarter of the interview subjects indicated that they knew of projects that had been halted or abandoned entirely because of rising insurance costs.

Rand made several recommendations for guaranteeing that property owners would have adequate coverage in the future. The researchers recommended that premiums be adjusted to fit the projected losses. In the case of New Orleans, premiums had been too low before the hurricane; afterwards the prices were likely set too high, according to Rand.

Part of the problem, Rand concluded, was that many companies relied on only one or two risk consultants to forecast the outlook for hurricanes. To keep premiums at realistic levels, Rand suggested that instead of setting prices based on hurricane forecasts from a lone risk-consulting firm, the insurance companies should use an average of several forecasts.

Many residents of the Gulf Coast have called for government to provide low-cost insurance, but Rand cautioned that federal intervention may not be the best choice. The government has long provided flood and earthquake coverage, the Rand report noted, and those programs have encouraged developers to build in dangerous areas. Rand argued that private insurers could continue to play an important role — provided the companies offer coverage at a fair price.

Affordable housing obstacles

While commercial properties of all kinds have faced high insurance costs on the Gulf Coast, the challenge has been particularly severe for apartment owners. Leases of many shopping centers and office buildings stipulate that insurance increases can be passed on to tenants.

But multifamily owners typically don't have such protection. Affordable housing developers face special concerns because government regulations limit rent increases — even when costs rise.

Despite the obstacles, HRI has moved ahead with eight affordable projects, including three scheduled to open by early 2008. The company has obtained coverage by maneuvering carefully.

For starters, HRI shopped hard. Before Katrina, the company relied on three insurance carriers. But now it has managed to cobble together a group of seven insurers to provide coverage.

Abbenante says that HRI was lucky to find a group of carriers willing to handle the policy. Some companies must cobble together 10 or 15 carriers. To be sure, the coverage is not as complete as in the past. While policies used to cover HRI's entire replacement costs, they now only protect one-third of the value of the portfolio.

In effect, the property owner is self-insuring — a polite way of saying that it is doing without. “We couldn't even get a quote for the full $300 million in coverage that we wanted,” says Abbenante. “We only got quotes for $100 million.”

In order to obtain coverage, HRI has redesigned some projects entirely. Originally, the company had decided to use wood for River Garden, a 310-unit mixed-use development. The project, which is to be 60% market rate and 40% affordable, was designed to blend into an old New Orleans neighborhood, which features century-old homes, many of them with ornate wood carvings.

But the lenders balked at supporting a wood structure, so HRI threw out the plans and began building the two-story complex of concrete, working to preserve the original flavor.

“This will hold insurance costs down and also reduce operating costs,” says Abbenante. “More than that, we want to make sure that when the wind blows, it will not hurt the property.”

Winds of change

Besides facing rising premiums, building owners have had to contend with higher deductibles for wind coverage. In the past, wind loss was covered as part of the overall policy; one premium covered fire, wind, and other hazards. But now wind is listed as a separate category, and it often comes with lower coverage and higher deductibles.

The total premium — including coverage for fire, wind, and flood — on a 25-story downtown office building in New Orleans rose from $150,000 to $500,000, says W. Anderson Baker III, president of Gillis, Ellis & Baker Inc., an insurance broker in New Orleans.

Deductibles on wind coverage alone jumped to 5% of the replacement value on the $80 million building. “That means you don't get any coverage until you pay $4 million,” says Baker. “It used to be that deductibles on many properties were a flat $10,000 for each incident.”

Faced with the high deductibles, many owners are simply doing without wind coverage, says Baker. “Even if they can tolerate the deductibles, building owners are reluctant to pay the high prices and then pass the costs on to tenants. If you own an office building in New Orleans, you have to worry about tenants leaving for Nashville or Dallas,” explains Baker.

Small owners get squeezed

The costs are greatest for owners of small portfolios that are concentrated in the Gulf Coast. Companies with diversified national holdings face limited cost increases. Insurance companies are willing to accept some risk in hurricane-prone areas in order to maintain lucrative relations with big customers.

Regency Centers Corp., which own 413 grocery-anchored shopping centers in 28 states, has properties in three major Florida markets — Tampa, Jacksonville, and Jupiter. Despite its hurricane exposure, the company pays about 50 cents per sq. ft. for property coverage in Florida.

“Someone who just owns one property on the coast of Florida is paying at least $2 a sq. ft.,” says Bruce Johnson, CFO of Regency Centers, based in Jacksonville, Fla. “Some people are considering leaving the state because the insurance is so expensive.”

Many Louisiana companies that renewed their policies in July 2006 faced a big hike in their premiums. But those renewing of late have found that prices have risen so high that insurers no longer see the need to continue raising rates.

“Starting in the last quarter of 2006, the rate increases started to level off,” says Lloyd Dixon, a senior economist at the Rand Corp., the research firm in Santa Monica, Calif. “The large diversified companies were starting to see actual declines. But the small policyholders in the Gulf Coast were not seeing cuts at all.”

Surplus insurance lifeline

In many cases companies have been forced to switch insurers. Commercial property markets are normally dominated by what are called the admitted companies, insurers with well-known names such as Travelers, The Hartford, and Chubb. These admitted companies fall under the jurisdiction of state regulators, which dictate maximum prices and the claim forms that can be used.

After Katrina struck, nearly all admitted companies stopped doing business on the Gulf Coast. Property owners were forced to turn to suppliers of surplus insurance lines, which are not heavily regulated and free to boost prices sharply.

Companies faced huge increases the first time they signed up for surplus lines coverage. “Property owners that moved to surplus lines last year typically got hit with increases of 200% or 300%,” says Baker of insurance brokerage Gillis, Ellis & Baker.

When building owners stopped paying the high-priced coverage, they technically went into default on their mortgages, says Don Beery, vice president of New Orleans broker Eustis Insurance & Benefits.

“When owners elect to do without wind coverage, that is certainly not in compliance with a mortgage,” says Beery. “Most lenders are looking the other way until this shakes out.”

While most of the cost hikes are blamed on wind coverage, flood insurance can also create problems. All commercial properties are eligible for federal flood insurance that provides $500,000 in coverage for a property and $500,000 coverage for the building's contents. Property owners who need additional coverage must go to the surplus market.

Not many owners have been buying, says Baker. “Before Katrina very few businesses bought surplus flood insurance. We still see few people taking it because prices have become so high.”

Stan Luxenberg is based in New York.

A roller coaster ride for property insurers

These have been good times for property insurers. After Katrina and other storms swept through the Gulf Coast in 2005, losses exceeded $50 billion, according to the Insurance Information Institute. Industry premiums that year totaled $425 billion.

In disaster-free 2006, industry premiums hit $443 billion. That helped insurers generate profits of $44 billion in 2005 and a record $63 billion in 2006. Recent strong profits are a change from the 1990s when premium income was lower and profit margins were smaller. In 1999, the industry recorded net premiums of $296 billion and net profits of $23 billion.

In the 1990s, insurance companies were recording big gains in their stock and bond portfolios. With the financial markets soaring, it paid for insurers to obtain more cash by charging relatively low premiums, says David Bradford, executive vice president of Advisen Ltd., a commercial property consultant in New York. Even without underwriting profits, cash from the premiums could be invested in the market for big returns.

But following the stock market collapse of 2000 and the $35 billion in losses from the World Trade Center terrorist attacks, it became clear that the insurers had been charging too little. “The reaction was to catapult prices upwards,” says Bradford. “What usually happens is that prices go way too low, and then the market overreacts and prices go too high.”

From 2000 to 2003, the cost of property insurance skyrocketed, but claims were routine. By the time Katrina arrived in 2005, the industry had enough cash to pay the hurricane claims and still record profits. Even though insurance companies weathered the storms of 2005, many industry executives were shaken and worried that global warming could produce bigger hurricanes in the future.

The insurance companies have long relied on risk modeling firms, such as Risk Management Solutions, to develop information on the hazards posed by storms and disasters. After the 2005 storm season, the risk analysts increased the expected frequency of hurricanes by 50%. Almost overnight, expected damages doubled.

At the same time, financial rating agencies, like Standard & Poor's, began insisting insurers hold more reserves in order to pay out bigger claims. Those increased costs for insurance companies put pressure on the industry to raise prices.

Now the cycle is easing, and prices are declining for properties outside the coastal areas. Their pockets loaded with cash, insurance companies are willing to cut prices in order to hold market share.

“Big property owners are in a position to negotiate pricing,” says Bradford. “Underwriters seem more willing to give on pricing, even for businesses that are exposed to potential catastrophes.”
Stan Luxenberg