While the events of Sept. 11 accelerated the increase in U.S. commercial real estate insurance premiums, property and casualty insurance costs had already begun rising in 2000, independent of terrorism-coverage costs, according to analysts from Standard & Poor’s.
Over the past seven months, property and casualty insurance premiums have increased by 10 percent to over 300 percent in some cases, and Standard & Poor’s expects these rates to continue to increase on renewals through the remainder of 2002. Yet, these increases, in and of themselves, have not materially impacted net cash flow or directly resulted in any downgrades of rated commercial mortgage-backed securities (CMBS) or real estate investment trust (REIT) transactions.
“What is driving this rise in rates is a shrinkage in capacity; the supply has declined,” Don Watson, a managing director in Standard & Poor’s corporate insurance group, commented. A year ago, because of the relatively soft market, there were several underwriters that were willing to provide $200 million, and more in some cases, in coverage on a single property. Now, it is difficult for large urban commercial properties to find coverage of over $25 million from a single source.
“There is a finite number of companies that could underwrite this business; there is also a finite number that believe solid returns are still possible given the risk of terrorism,” Watson explained. “Yes, you could still put together a package, but it is challenging; it takes longer. Furthermore, the package costs more and requires higher deductibles, greater co-insurance, and frequently less coverage.”
It has been estimated that claims resulting from the attacks will cost the insurance industry in excess of $30 billion dollars. “As a result of Sept. 11, insurers have revisited their worst-case scenarios to measure the severity of risk, but when it comes to terrorism risk, the reality is that you cannot measure the probability of its occurrence. Consequently, insurers have reduced the overall amount of insurance coverage they are willing to offer in order to limit their exposure to greater losses against their capital base,” Watson commented.
Standard & Poor’s CMBS group expects to see these increases in costs for property and casualty insurance reflected in issuer underwriting. Standard & Poor’s will continue to monitor borrower ability to absorb these expenses or pass through these costs to tenants, and what the resulting impact is, if any, on net cash flow. In fact, so far, despite increases in insurance premiums, these costs remain a relatively small percentage of the overall property’s expenses because a significant amount of renewals occur in June and these increased costs have not yet been reflected in borrower net cash flow.
“Even with insurance expenses increasing on average 30 percent, it still, in most cases, represents only about 1 percent to 3 percent of a property’s expenses. This addition to overall expenses, by itself, will not in most cases make a dramatic difference in debt-service coverage,” Roy Chun, a managing director in Standard & Poor’s surveillance group, remarked. “Standard & Poor’s has not yet had to downgrade a transaction due to rising property and casualty insurance premiums,” he added.
“Rated REITs have also reported material increases in property and casualty insurance costs,” Lisa Sarajian, managing director of Standard & Poor’s REIT group, said. “But these costs have risen during a time when other operating costs have fallen, which has helped to cushion the impact,” Sarajian said. Thus, there has not yet been any significant impact to the operating cash flow of REITs due to rising insurance premiums.
Insurance rates are not expected to drop back to their pre-2000 levels any time soon.
However, Standard & Poor’s insurance group does expect some moderation of property and casualty insurance premium rates at the time of annual renewals in 2003 as more insurers enter the market anticipating a greater return for the risk.
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