Why are commercial real estate rates seeing year-over-year increases?
Real estate insurance rates are up 33% year-over-year while accounting for nearly 10% of an owner’s quarterly per-unit operating expense, according to a report by Marcus & Millichap.
According to Tom Lynch (pictured), Jencap’s senior vice president, this is due to “the way that claims are being litigated and their payouts, plain and simple.”
“However, it goes both ways, if these buildings are in poor condition, they’re not being physically maintained and people are tripping and falling in and around the property, the onus is on the landlord or building manager.”
In a conversation with Insurance Business, Lynch spoke about why this is a tough business class to insure. He also revealed whether new entrants into the space have been pricing incorrectly and whether he sees these rate hikes plateauing or decreasing anytime soon.
“Insurance companies have to underwrite to create a profit”
According to the Marcus & Millichap report, “Insurance costs are rising at an accelerated rate for commercial real estate, while providers concurrently implement new policy limitations to decrease their exposure.
“Together, these dynamics are eroding commercial real estate owners’ and developers’ margins, especially in states with higher environmental risk factors, including Florida, California and Texas.”
Reflecting on this data, Lynch noted how habitational, or commercial insurance, continues to be a tough business class to insure.
Since these spaces house multiple tenants, with visitors coming and going constantly, their risk profile increases exponentially.
“All it takes is one person over the course of a 365-day span to file a claim,” Lynch said. And depending on the severity of that claim and the ensuing litigation, a pretty hefty payout can be expected.
Meanwhile, “insurance companies have to underwrite to create a profit,” Lynch said.
Companies that have been writing business in this space for a while have the analytical tools to back up these prices and need to be transparent with insureds about the negotiation and data mining that goes into each policy.
“While it may not make sense to the consumer, in order for us to even stay in this space in business and be able to pay your claims out, these prices must be where they’re at,” Lynch said.
In his 10 years, the SVP has noticed that many new entrants have come into the space, with a promise to offer rates that are half of what their more established peers are able to underwrite.
“However, the ones who seem to stick around the longest underwrite with integrity, have managed claims and know what to expect setting reserves and defense costs,” he said.
Using emotion instead of legitimate data
Further expanding upon the impact of new entrants into the commercial real estate space, Lynch noted that some budding carriers are unsustainably offering lower rates to lure consumers.
This is driven by a “web of greed” where offering lowered rates to a larger pool of insureds is seen as a good business proposition, Lynch said.
Lynch is quick to note that these carriers are well-intentioned, but they are playing to consumer emotion rather than the legitimate data that might negate their pricing.
“For example, they charge a very cheap rate, let’s say $100 per unit for a 1000-unit building, collecting $100,000 in premium,” Lynch said.
“Something, unfortunately, goes wrong, and now the insurance company is paying $250,000 for that claim. Think of the price they’re going to have to charge the following years for that risk to be profitable.”
What this results in is consumer mistrust since they were initially promised a particular rate that will substantially bloat to recover from a loss or shuttering an operation completely due to a nuclear verdict.
At the end of the day, pricing has to make sense for the insurer
With a healthy bit of optimism, Lynch noted how insurers with a firm grasp of the market have been able to price and adjust accordingly.
It would not make sense for a carrier to write a coverage if there is no return on investment, but that should not scare away consumers from procuring a policy.
“For the folks who are doing things properly there are ways to get involved in better insurance programs. And when you do well, when your claims perform well, your premium is going to reflect that,” Lynch said.
An insurer or broker can significantly mend a policyholder’s risk profile by educating them on how to better safeguard their building from any threats or exposures that commonly lead to a claim.
“Sometimes it’s the building not being in good shape or there are handrails missing from the staircase. There’s a defined middle ground that the insurance company can educate on and try to make everyone happy,” Lynch said.