U.S. commercial real estate (CRE) values in coastal areas, and in particular smaller multifamily properties, may suffer as insurance companies reduce loss exposure to hurricane-prone areas by increasing premiums, raising deductibles, dropping coverage amounts and even dropping coverage altogether following the most active and most expensive hurricane season in 2005, according to Fitch Ratings.
“CMBS servicers have noticed a sharp increase of anywhere between 25 percent and 400 percent in windstorm and flood insurance premiums since the official start of the hurricane season on June 1,'”said Joseph Kelly, Senior Director, Fitch Ratings. “This may present a problem for commercial real estate properties where premium increases cannot be passed through to tenants, and in fact the resulting value decline may be severe enough so a property can no longer support its full debt service, increasing the likelihood of payment default.”
As premiums increase, and in some cases even skyrocket, the same is happening to deductibles, as Fitch has seen increases of 10 percent to 15 percent of replacement value for renewals, compared to 2 percent to 5 percent last year. Some CMBS servicers are requiring borrowers to provide guarantees to cover the difference between the two deductibles to mitigate the additional risk.
With some insurers placing caps on windstorm coverage and even dropping coverage all together active, “Fitch’s chief concern is that windstorm insurance along coastal areas may become commercially unavailable, possibly echoing in severity the terrorism insurance issues of late 2001/early 2002,” said Senior Director Patty Bach.
Key questions arose after Katrina, as much damage was caused by flooding, not by wind. Almost all residential property and casualty (P&C) windstorm policies specifically exclude damage caused by flooding (including storm surges), and have so for many years. Since private insurance companies were largely unwilling to underwrite and bear the risk of flood because of its catastrophic nature, the National Flood Insurance Program (NFIP) was created in the late-1960s to provide insurance coverage for flood damage.
Unlike the residential insurance market, many commercial P&C insurance policies are negotiated contracts and therefore may or may not cover flood damage depending on the terms of the individual policy. Some standard commercial property policy will provide excess flood coverage after a NFIP policy. NFIP insurance not only provides primary coverage, but also helps lower premiums and increase availability of excess flood coverage in the private market. Currently, NFIP flood coverage on commercial properties is capped at $500,000 for the building and an additional $500,000 can be purchased to cover a buildings contents. Congress is currently working on proposed changes to the NFIP, which among other things would increase the current coverage limits. NFIP policies currently do not cover business interruption insurance.
Mortgages secured in CMBS typically carry P&C insurance coverage equal to the replacement cost of the property. The majority of P&C insurance policies include wind as a covered peril, except for properties located in close proximity to the coast. Close proximity definitions differ by insurance companies and their risk appetite. For example, some insurance companies exclude wind for properties located within 20 miles of the coast, others 100 miles. When wind is excluded, a separate wind policy or rider needs to be purchased.
Fitch plans to host a forum to further explore the issues surrounding windstorm insurance and the potential impact on the CMBS market.
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