Inside Insurance Brokers' Efforts To Cover Commercial Property In 'Crisis Mode'

Skyrocketing insurance costs for commercial property have placed insurance brokers in the middle of increasingly frantic negotiations, straining to forge deals and cobble together coverage to allow projects to move forward. 

Higher prices have added costs to ongoing development and existing properties, straining budgets in particularly disaster-prone regions and pushing firms industrywide to re-evaluate existing policies and, in some cases, take less coverage.

“This is really an unprecedented time in both real estate and insurance markets around pricing, it’s crisis mode,” said Danielle Lombardo, chair of the global real estate practice at Lockton, the world’s largest privately held insurance brokerage. “It’s going to be the factor that makes the deal go or not. Each dollar of insurance has a negative effect on net operating income, and with some policies going up by millions of dollars, that's the difference between a cash flowing property and a property going into foreclosure. People are, I would say, desperate.”

Premiums for commercial property leapt 18.3% in Q2 of 2023, according to data from the Conference of Insurance Agents & Brokers, the largest such jump in any category it tracks. Construction insurance surged 10% to 15% in 2023, and a June survey by the National Multifamily Housing Council found insurance for multifamily projects has increased an average of 26% in the past year. 

But the spike in insurance costs hasn’t stopped development in risk-prone areas, meaning a steady build-up of high-value properties in the pathway of an increasing volume of storms and billion-dollar disasters; Florida is just a “ticking time bomb,” said James Darby, executive vice president at RT Specialty, which focuses on hard-to-insure clients.

This year’s just-commenced Atlantic hurricane season could have profound impact on insurance rates, Lombardo said, and add to the market’s wild swings; a year with fewer storms and no significant damage would allow the market to stabilize, with prices only going up 5% or 10%. But, if there are megastorms that wreak havoc, she believes premiums could go up 50%, or even double next year.

“It’s always about the unknown,” said Chip Stuart, executive vice president at Hub International, a large North American insurance brokerage. “This is kind of like the day after 9/11 for us, on a continuing basis.”

The current scenario of rapidly rising premiums nationwide, paired with continued development in high-growth, high-risk markets like Texas, Florida and California, results from a confluence of changing weather patterns, huge payouts from recent storms and the increased value of commercial real estate.

The stakes mean insurance brokers, caught between navigating risk data and helping meet lender insurance requirements, need to work 10 times as hard, Lombardo said. They’re often piecing together a quilt of smaller policies from different carriers, who don’t want to take on the full risk of a property getting damaged, and negotiating with entire teams of stakeholders and executives at real estate firms who have suddenly prioritized insurance costs. 

They also have to be blunt about the reality of the situation, especially when real estate brokers paint a rosier picture of what’s possible and what premiums cost. Lombardo has dealt with situations where real estate brokers set unrealistic expectations about what’s achievable; she claims she’s seen some put out graphs that say Florida property insurance should be going down next year, when Florida is “the riskiest piece of land in the world.”

And in many markets, the pool of options is shrinking. Allstate and State Farm announced plans earlier this year to stop writing commercial policies and pull out of California. Lombardo has seen people walk away from deals because of the insurance pricing, primarily in Florida.

In addition to the predictable and steep rising cost of hurricanes and wildfires in recent years, a parallel increase in more unexpected events, such as deep freezes — Winter Storm Uri in 2021 caused $10B in damages in Texas​​ — and so-called convective weather events like hail storms and tornadoes, have eaten into insurance carriers’ cash reserves.

Lightning storms alone caused $34B in insured losses in the first half of 2023, per Swiss Re. This year alone, Lombardo said, the amount of catastrophic losses to these kinds of unnamed wind events was double the 10-year average.

Since all policies and CRE insurance draw from the same pool, carriers simply aren’t raising premiums enough to cover these losses. 

“You’re in this big pool with everybody else, and if there's no water in the pool, and you jump in, it hurts,” Stuart said.

The damage from last fall’s Hurricane Ian in Florida, estimated at $65B of insured loss, ratcheted up the pressure and prices, leading to a wave of policy revamps and pushing brokers to be more communicative and proactive as they manage increasing risk and nervous clients. 

“When you put your ear down and hear a stampede of buffaloes out in the distance, you start reaching out,” said Alexandra Glickman, senior managing director of Gallagher’s real estate and hospitality service. “No one knew how quick the market was going to turn.” 

For roughly the last decade, most large developers and CRE firms focused on aggregating their insurance risk. By pooling together property in different markets and buying comprehensive insurance coverage, they could benefit from economies of scale and lower their costs. If a portfolio has apartment buildings in 10 Sun Belt metros, for example, the owner can purchase enough coverage to handle a catastrophic event in the most exposed market, since it’s incredibly unlikely multiple events would happen in the same time period. 

Bainbridge, a large multifamily developer with a majority of its portfolio in Florida and a Lockton client, just met with insurers to determine re-upping its policy in December. The firm will likely pay nearly double the rate, yet receive half the coverage, due to the loss of insurance capacity in the market.

“One of the biggest struggles has been the lack of capacity for multifamily real estate in Florida,” Bainbridge Chief Financial Officer Chris Phillips said. ”We look at our return on cost, and if our return on cost doesn't work, we just don't move forward with a deal. It may not be all insurance-related, but it's a big piece of it.”

Bainbridge, which concentrates on the Orlando, Tampa and Jacksonville markets, does extensive research before acquisitions, especially wind and flood modeling. Even sites 5 miles apart can have much different risk profiles, and higher insurance costs will often make a deal unfeasible. 

Recent weather patterns have altered the portfolio strategy for many. Most damaging to larger CRE firms and investors, growth continues in areas of increased disaster risk, especially the fire-prone wildland-urban interface in California, or sprawling North Texas suburbs at risk of hail and tornadoes. That means expensive and appreciating assets that need coverage sit in the path of more disasters. Since all insurance payouts come from the same pool, the cascading nature of disasters pushes premiums up for every client.

This elevated risk means skyrocketing costs for these larger policies, so much that Florida properties, for instance, tend to drive up the cost for the entire portfolio as a whole.

Over the last 18 months, firms have been racing to silo their properties, according to Darby, creating Florida- or Texas-only policies to cover their most at-risk assets, and leaving everything else in a blanket aggregate policy.

Reinsurers, which provide insurance to the insurance firms and serve as a backstop to the industry, have been hit by five years of $100B-plus annual losses, leading them to be risk-averse, pull back and approve fewer policies, which drives up costs and provides less capital to write more policies.

Glickman said global reinsurance capital dropped 15.7% at the end of 2022 to just $355B; not a lot of money when considering the sharp rise in extreme weather events that have happened thus far in 2023. That drop in capacity among reinsurers pushed insurance companies to pay higher rates for reinsurance, and pass those costs on to developers and property owners. 

Commercial owners also find themselves adjusting their premiums to account for rising construction costs and valuations. Reinsurers have pressed the carriers to push firms to recalculate values to keep in line with rising construction costs and the true cost of replacement; typically in past years, firms undervalued their buildings to lower their insurance costs. This dynamic becomes particularly dire when paired with the so-called urban doom loop, where there is an inversion of replacement costs relative to fair market value.

“Say you have a commercial office where the fair market value today is $200 per SF,” Glickman said. “But the replacement cost is still $400 per SF. Your premium is a function of that replacement cost, not what you can get in today’s market.”

There are actions that CRE firms can take, beyond moving investment into less disaster-prone regions, to try and mitigate these rising costs. Glickman suggests her clients tell the truth and adjust their valuations, and make painful but valuable capex investments to lower risk and premiums, especially water damage mitigation, and if properties are in an area conducive to hail and tornadoes, better roof systems. 

But many of the solutions being advanced require systemic or governmental change.

Lombardo suggests lenders take a more specific, data-driven approach to setting insurance limits, utilizing better forecasting models to temper requirements instead of mandating full coverage.

There are also some novel data-driven concepts being rolled out by new carriers, such as FloodFlash, a British firm that installs water detection devices on-site to determine the extent of flood damage, utilizing advanced analytics and precise measurement in an effort to better analyze risk and reduce premiums. 

Others expect governmental involvement and support of the insurance marketplace, something akin to the National Flood Insurance Program, or another mechanism to help bolster the market and prevent too many catastrophic events too close in time or geography from overtaxing the system. 

“If you can’t insure it, is it valuable?” Stuart said. “So far, the answer is no. But I’ve talked to clients who are putting the brakes on developing new apartment buildings in brush-filled areas, who don't want to be on the market trying to sell units when they know that getting insurance for those is going to be difficult or impossible.”