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While lenders, investors and developers may be more aware of specific insurance challenges, a combination of rising costs and contracting availability of required coverage is trickling down to impede business activity for a wide spectrum of real estate organizations.
As in communities ravaged by natural disasters, businesses and individuals can help their clients and the industry by learning about the market’s response to elevated risk, the threats it can pose, and effective strategies to minimize its detrimental effects.
Calamity and cost. Weather-related disasters are growing more numerous — and costly. The frequency of weather disasters increased by a factor of five over a 50-year period through 2019, the World Meteorological Organization found. Last year marked the eighth consecutive one during which the U.S. sustained 10 or more separate billion-dollar disasters, according to National Oceanic and Atmospheric Administration tracking.
Facing massive volumes of claims and litigation in the wake of recent hurricanes that left many small insurers insolvent and forced others to exit the market, some remaining insurers have tightened underwriting, and are denying renewals on thousands of policies along the Gulf Coast. In fire-ravaged California, two of the nation’s largest insurance companies recently stopped accepting applications for new policies.
With insurers increasing premiums, limiting coverage, or ceasing to offer policies in disaster-prone markets, more borrowers are struggling to obtain sufficient insurance to satisfy their loan agreements. Further exacerbating this problem, building material and labor costs have increased.
Emerging risks. Borrowers must worry about not only collateral risk, but also the possibility that new technology will preclude their ability to obtain insurance coverage that lenders require. When using predictive modeling that incorporates climate change, lenders may conclude a loan applicant’s real estate is in a high-risk area, even if the historic record for the location shows no unusual frequency or tendency toward disaster-related collateral damage.
Insurers aren’t the only ones using advanced models that ultimately affect commercial real estate owners. Lending underwriters are making climate risk decisions based on historical data, modeling and expectations for further changes to risk levels. For borrowers, those decisions can translate into more extensive insurance coverage requirements on their loan, lower loan-to-value, a higher interest rate, reserve requirements or other provisions that increase their overall cost.
Response strategies: Seek out specialty insurance companies, which offer coverage for unique or challenging situations. Insurance brokers can inform clients about which insurers are actively issuing policies in their market and product type, and alert them to conditions or locations where borrowers have encountered difficulty obtaining coverage. Likewise, inquire about deductibles and loss limits that can meet your budget and risk.
Lenders and their underwriters should pay attention to insurance trends for commercial real estate and weigh the necessity of requiring coverage provisions that insurers tend to exclude or refuse. Adding optionality for a borrower to self-insure, if obtaining traditional insurance coverage is not feasible, may be a viable option for some borrowers. Borrowers that set aside funds to cover potential property loss or damage can protect their investment.
A lender may open themselves to a larger pool of borrowers if they are able to offer alternative means of mitigating specific risks for which borrowers can no longer procure or afford insurance coverage. Borrowers should explore state or government programs available to assist in markets where traditional insurance coverage is unavailable.
Developers, buyers and owners can explore opportunities to achieve lower premiums or lower deductibles through design features or structural improvements that lower physical risks connected to climate change. Take advantage of any insurance discounts for improving the structure’s energy efficiency, reducing water consumption, or shrinking its carbon footprint.
Longer term, the commercial real estate industry should expect mounting regulatory demands aimed at reducing the environmental impact of commercial construction and building operations. When new laws assign penalties or shift responsibility for a building’s environmental infractions, look for insurers to adjust coverage and pricing in response.
Real estate professionals can communicate with their elected officials and share their perspectives through the government affairs programs of state and national professional organizations.
Cindy Barreda is senior managing director of credit administration for the Americas at investment adviser Trimont.
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