Exploring the Uptrend in Costs of Insurance

One of the greatest challenges in operating commercial real estate (CRE) has been the spike in insurance costs in the past few years. So much so that the rate at which insurance costs have risen has outpaced rent increases and general inflation.

According to Moody’s Analytics, commercial real estate insurance costs have surged by an average of 7.6% annually since 2017, impacting the bottom lines of both the property owners and the investors.

The Council of Insurance Agents & Brokers also confirms that the average increase in commercial property premiums has recently spiked to 20.4%, which is the first time since 2001 that it has crossed 20%. The impact is threatening, as rising costs eat into profits and make ESG compliance even more crucial for property owners.

A deeper analysis of what is causing the rise in insurance costs reveals three primary factors, the most significant among which are natural disasters and their increasing regularity and severity.

Urbanization has caused more people to settle in areas with higher climate risk, drawn by factors such as cheaper housing, jobs, and favorable weather. Developers also responded to this increased demand by building in regions that were susceptible to wildfires, floods, and other hazards.

At the same time, events like hurricanes, wildfires, and other climate-induced incidents have transitioned from being rare to being persistent dangers, putting commercial properties at risk of extensive damage. Worldwide, natural catastrophes have increased by 22% from 2021, 11% of which have been covered by insurance.

With these events occurring more often, insurers are compelled to revise their risk evaluations, resulting in either elevated insurance costs for property owners or reduced coverage for the same premium.

Insurance policies have become most stringent for properties located in coastal regions or areas susceptible to natural calamities, including earthquakes, floods, and wildfires. As a result, insurance expenses are notably higher in states like California, Texas, and Florida.

A Deloitte study indicates that by 2030, the cost premium of being in a higher-risk extreme weather state could be 24% greater than the national average, compared to a 32.5% discount in lower-risk states.

The escalation in insurance premiums for multifamily properties is closely correlated with the soaring natural disasters in the US that incurred damages beyond $1 billion. In 2023, there were 28 separate billion-dollar extreme weather events with estimated recovery costs totaling $92.9 billion. This led to a 56% increase in insurance costs from 2022, and up 180% from levels 10 years ago.

Inflation is another potent force propelling insurance costs to unprecedented heights. With the general increase in the cost of goods and services, there is a corresponding rise in the costs of labor and construction materials in rebuilding properties.

In case of disasters, property owners not only have to bear the consequences of disasters but also grapple with the increased costs of repairing and restoring their assets. Consequently, they are compelled to insure the property for a greater value, leading to higher premiums.

The surge in insurance costs has also significantly impacted property sales, influencing the strategic decisions of investors. While 68% of the estate investors confirmed being impacted by rising insurance costs in their buy or sell decisions, CoStar group reported an astonishing 79% decline in deals exceeding $25 million since late 2021.

However, reinsurers are becoming more wary as risks evolve, limiting their coverage and making it dearer by raising premiums.

This reduction in available coverage and the resulting higher costs are directly passed on to property owners, forcing them to pay more for the same coverage at the time of policy renewals or being denied coverage by way of non-renewals. Consequently, the property owners are drawn to embrace new policies at elevated costs.

While insurance costs continue to increase unabated, there are some strategies which property owners can adopt to reduce insurance costs in commercial real estate:

1. Risk Management: Property owners can implement robust risk management practices, such as regular property inspections, preventive maintenance, and safety measures so that the risk of damage to the property can be suitably reduc This is a comforting factor for insurers, and they reward proactive risk reduction by way of reduced premiums. Properties with lower risk profiles can secure good coverage at good rates with a minimal increase of 0–10%.
2. Robust Building Materials: When constructing or renovating properties, the owners must use materials and construction techniques that can minimize losses. Choosing durable and climate-resistant materials like fire-resistant blding materials, automatic plumbing shutoff controls, and hail-resistant roofing and siding that can withstand extreme weather events reduces risk.
3. Higher Deductibles: Policies with higher deductibles usually have lower monthly premiums due to the inclusion of greater out-of-pocket expenses for the owners in the event of a claim. This approach is especially advantageous if the property is in a low-risk area or has robust risk mitigation strategies.
4. Bundling Policies: If the property owner has multiple properties, they can bundle some of them under a single policy and benefit from discounts. Bundling also ensures consistent coverage across all properties, reducing the risk of gaps in insurance protection. However, it is important to ensure that bundled policies meet the specific needs of each property while being cost-effective.
5. Security Measures: It is beneficial for the owners and operators to actively prevent damage or liability claims by installing security systems, fire alarms, and sprinklers to garner savings in premiums. Owners must not only maintain the property well but also provide detailed data on renovations and maintenance, such as new roofing, plumbing and electrical. In case they do not document and report them to the insurers, the insurers ought to presume that buildings have not been renovated and they assess risk accordingly, making the coverage more expensive.
6. Clean Claims History: It is also pertinent for the property owners to maintain a good claims history. Frequent claims can raise premiums significantly; hence, minor incidents should be managed without involving the insurance whenever possible.
7. Review Pass-Throughs: Owners must evaluate what costs they can push to the tenants by reviewing their leases. Net leases allow the landlord to charge the tenants for the proportionate share of insurance costs, thus ensuring that increased costs can be adequately apportioned among the tenants.
8. Obtain Parametric Policy. In regions where property insurance capacity is in short supply, property owners can consider obtaining parametric insurance. These are special policies that reimburse the holders a specified amount depending on the magnitude of the event even if there is no loss to the property.
9. Review Lender’s Insurance Compliance Requirements: It is crucial to review the Lender’s Insurance Compliance Requirements from time to time, especially now when coverage costs more to provide. This is because some of their requirements may be non-critical and hence could be negotiated.
10. Explore Insurance Options: Finally, it is worthwhile comparing insurance quotes from different providers. This is because each insurer evaluates risks differently; hence, exploring multiple options can help find the most competitive rates.

Given the essential role insurance plays both on the ground for victims of climate-linked disasters and for the broader global economy, insurance companies, regulators, and policymakers need to find new ways of doing business that protect property owners by ensuring the affordability and availability of insurance products.

Pervasive risk requires innovative responses. Insurance solutions need to go beyond traditional risk transfer and insurers must develop insurance products specifically to cover climate-related risks.

With the long-term viability of the industry at stake, it is imperative for insurers to build resilience, adopt sustainable practices, and rethink insurance strategies that are effective in safeguarding communities and the environment.