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Commercial insurance update.

For the last five or six years, commercial property insurance rates have either held steady across the country or have gone down. In insurance parlance, this is known as a "soft" market. During soft markets, insurers lower rates to attract business, broaden their coverages to make their products more attractive, and accept risks that under other circumstances they might turn away.

The current trend, however, is that this soft market is firming up. A firmer market means changes for you as a buyer of commercial property insurance.

Three main reasons for the swing from a soft market to a hard one are:

* Insurance is a cyclical business, and it is time for the pendulum to swing the other way.

* Recent catastrophic losses around the United States have placed a severe drain on insurance companies' resources.

* The slow economy has made it more difficult for the insurers to obtain strong returns on their investments, thus putting more pressure on the need to raise reserves via increased premiums.

Two changes you can expect in a firmer market are higher rates and increased emphasis on supplemental coverages such as Difference in Conditions, Ordinance and Law, and Director's and Officer's.

Rising rates

Rates for commercial property insurance have begun to creep up and are expected to rise even more in the next year. Depending upon what part of the country you live in and whether or not you have sent your policies out for review yet, you may have already felt some of these increases.

As Chuck Hersh, senior vice president of marketing for Segwick & James, based in Portland, Oregon, pointed out, "The big question is when, not if."

In Seattle, for example, Bob Smith of Stanley T. Scott Insurance Brokers claimed that he had seen consistently flat-to-declining rates in the Pacific Northwest every year since about 1988. By the end of 1993, however, he expects rates across the board to rise by as much as 7 percent.

On the other hand, Richard Boynton, president of the Towle Agency in Minneapolis, predicted rate jumps as high as 15 to 25 percent in some areas. "It won't be as bad as the increases in 1985," he said.

Many insurance companies, however, are reeling from the catastrophic losses of 1992 and that, coupled with low earnings on their investments, makes an upward adjustment in policy costs inevitable.

One way to ameliorate the effects of higher insurance costs is to carefully examine the insurance burden created by each property in your portfolio.

Re-evaluate values

"In the past, it has not been so important for a property manager to know the precise value of every property in his or her portfolio," said Hersh. "In a soft market, you can get away with a lot of things in terms of values and rates."

With the market firming up, however, all that has changed. "Because property insurance keys off values," said Hersh, "now is the time to make sure that the rental income and loss-of-rent figures are correct and that all of your buildings are insured correctly."

For example, suppose you have an older Class-B office building downtown. You've been insuring it off the tax rolls. Hersh suggests that now might be a good time to rethink that strategy.

"The replacement cost of the building might be $2 million, while the actual market value is only $1.2 million. If there's a partial loss, you might want to fix it and keep the building in service. If there's a total loss, it might be better to collect $1 million and invest the money somewhere else," said Hersh.

Because policies can be written on replacement cost, actual cash value, or a stipulated amount, Hersh recommends that you carefully evaluate each property in your portfolio for the most effective option. "That way," he said, "you're only paying for the insurance you actually need."

However, Larry Biga, CPM |R~, of the L.W. Biga Co., Dayton, counseled that you should avoid being drawn into the property valuation process, either by setting value or agreeing to value.

"The insurance companies often want to dump the notion of values onto the managing agent," said Biga. "I simply refuse to do that. I will gather information for them, but the insurance company should determine the value and the owner should make the ultimate decision."

In a hard market, it is more important than ever to work smart. Property owners will apply pressure to keep costs down. Insurance companies will be pressuring prices up. As the property manager, you may be caught in the middle.

To shop or not to shop?

Shopping around for the best price is generally considered good advice. Unfortunately, that may be counterproductive in a hard market.

According to Bob Kurdziel, president of Risk Management Group, Atlanta, "Shopping your business around every year is a real aggravation to everyone and only speaks ill of you in the long run."

Towle Agency's Boynton agreed: "If underwriters see the same account come across their desk year after year they don't take it seriously--they don't even bother to quote." Not only that, but with insurance companies becoming more concerned with bottom-line profitability, you may find companies refusing to quote, when in the past they were more than eager for your business.

This happened to Craig Suhrbier, CPM, regional vice president of SUHRCO Management, Inc., AMO |R~, in Kirkland, Washington. "When we went out to bid our portfolio again this year," said Suhrbier, "we actually had one or two companies decline the opportunity to quote. They said they were no longer quoting commercial and/or multifamily residential."

Just because an insurer is willing to quote does not necessarily mean that company is the best one with which to go. The problem, said Mark Baker, CPM, of Coldwell Banker-Schmidt in Grand Rapids, Michigan, is developing a short list of insurers in which you can be confident.

"It is one thing to shop price, then look at their ratings and make a decision," said Baker. "The real key is: How do the companies do on the claims side? That's where property managers are at a real disadvantage, in knowing the claims history of different companies."

Go for stability

During 1992 and the beginning of 1993, many insurance companies experienced problems. A number of insurers failed or became more critical about what properties to insure. The effects on insurance rates and coverages have been far-reaching.

The problems were triggered by difficulties in the reinsurance market. They were exacerbated by low investment returns, low premium income, and a series of natural and human-caused disasters that included Hurricane Andrew, the Oakland fire, the "Storm of the Century" on the East Coast, the World Trade Center explosion, and renewed earthquake activity in California and Oregon.

The catastrophic losses incurred by these disasters have driven many of the reinsurers out of business and, in domino fashion, have directly affected the primary insurers as well. Primary insurers depend on reinsurers to help them cover liabilities that they, because of insufficient cash reserves, cannot fully cover by themselves.

If the reinsurance market dries up, primary insurers must either increase their rates to customers to build up cash reserves or increase their risk-to-reserves ratio and hope they do not get hit with any major claims.

Lately, according to Boynton, many insurance companies have been taking back the excess risk, with unsettling consequences. "Many major companies have combined ratios that exceed 125 percent," he said. "Some are as high as 140 percent. Typically a combined ratio in the area of 117 percent is indicative of a problem. Something has to give."

The risk, of course, is that the "something" may be the health of the company you have chosen to insure your portfolio.

One strategy to reduce this risk is to move your insurance to a larger company. According to a report by the A.M. Best Company, Oldwick, New Jersey, smaller companies are far more likely (63 percent) to become insolvent than large companies (only 3 percent). Best defines a small insurance company as one with less than $5 million in policy-holders' surplus and a large company as one with $50 million or more in policyholders' surplus.

Another strategy is to consider placing your insurance with a carrier that works across a number of geographic regions. According to A.M. Best, six states (New York, Texas, California, Pennsylvania, Illinois, and Florida) accounted for 50 percent of insurance company insolvencies in the 10-year period of 1980 to 1990, even though only 34 percent of all insurance companies are based in those states.

Difference in Conditions coverage

Because of recent natural and human-caused disasters, one type of coverage that is becoming increasingly important for commercial properties--as well as considerably more expensive in certain areas--is Difference in Conditions (DIC). This coverage essentially wraps around a standard named peril policy to convert it into all-risk coverage.

DIC coverage typically insures against losses caused by wind, hail, falling aircraft, riot, vandalism, earthquake, flood, and the like. Even so, some companies in certain geographic regions may require separate riders for earthquake, flood, and/or wind damage.

In the California earthquake zone, for example, "DIC coverage is going through the roof," according to Hersh. In addition, these same insurance companies are significantly raising their deductibles. For property managers and building owners, the question gets right back to cost and affordability.

"If we have a $50-million building in California," said Hersh, "and the bank says we have to have insurance on it, we have to ask some serious questions. The bank's requirements apply only to the loan, so if we have a $20-million loan on that property, we may want only $20 million of earthquake insurance.

"The question becomes what do we have to have," he continued. "The cost difference can take a property owner from in the black to in the red."

Ordinance and Law coverage

Another coverage to be more aware of is Ordinance and Law (O&L) coverage. This has become more important because of increased passage of and enforcement of local building and environmental codes. In the past, O&L coverage was generally restricted to acts of civil authority.

For example, the building next to yours is on fire and the fire department demolishes your building in order to put out the fire. O&L coverage makes it possible for you to rebuild. Or, as in the case of the merchants in the aftermath of the World Trade Center explosion, you and your customers are kept away from your place of business by civil authorities. O&L coverage allows you to recover for lost income.

Presently, if an older building is damaged, it must be repaired to meet current building and safety codes. This can add considerable expense if your building was valued without these modern upgrades.

However, what if the building is only partially damaged? In some cities, such as Portland, Oregon, the local fire marshal has the authority to require a building owner to remodel the entire property to current code, even if only 10 percent of the property was destroyed.

These new building codes can affect everything from plumbing to electrical wiring, sprinklers, handicapped access, and earthquake reinforcement. The older the building is, the bigger the potential risk and the replacement cost. In most situations, the only way to cover such expenses is through additional endorsements to O&L coverage, usually at increased cost.

On the plus side, many companies have come out with less restrictive O&L coverage that helps address some of the additional expenses brought on by EPA-mandated clean-up rules.

"Generally speaking," said Scott Brokers' Smith, "those kinds of coverages are being offered at little or no cost to the buyer. Companies are now offering broader coverages for glass, debris removal, and demolition."

Director's and Officer's coverage

A third area to be aware of is Director's and Officer's coverage (D&O). This coverage is in addition to the basic liability policy. It is typically written to provide coverage for the board of directors in a condominium association to protect the directors against wrongful-act suits.

For example, if a condominium association's bylaws prohibit certain activities or uses within the building, such as not permitting recreational facilities, and the board then installs a swimming pool, D&O coverage would protect the board members from being personally liable in any suit brought against them.

Recently, however, in response to concerns from building owners and property managers and in realization of certain changes taking place in society, many insurance companies are expanding their D&O coverage to include employee discrimination and wrongful-termination suits based on age, sex, and sexual orientation. Some companies also include sexual harassment in that coverage, although most insurers write that up as a separate policy.

"A well-run company with good employee policies and procedures will have less need of such coverage and will be a much better risk," said Kurdziel. "Even so, we're seeing a number of companies--not just property management companies but doctors and lawyers--that are buying this type of insurance."

According to Boynton, the trend is likely to continue. "As we read more and more about the exorbitant settlements in some of these suits, most medium- to large-sized companies will purchase the coverage," he said.

"Other insurance" clauses

Smith is particularly concerned about the so-called "other insurance" clause that appears in various insurance companies' policies. Such a clause, he said, "makes the property manager's insurance primary for a liability loss at a location that he or she is managing."

According to Smith, the only protection against this type of claim is to carefully read the "other insurance" clause for the property you are managing and then alter the contract to nullify such a condition.

State Farm Insurance is one company that typically includes an "other insurance" clause in its commercial property policies. Jim Fricker, a State Farm zone underwriting consultant, said that State Farm normally thinks of the "other insurance" clause as one in which "another insurer is involved and the loss would be settled on a pro-rata basis where both carriers would share in the loss equally or in relation to the amount of coverage they had on the building."

He also said that in many cases the policy is written so that the State Farm policy will cover only the amount in excess of the amount covered by the other policy--precisely the object of Smith's concern.

Fricker did acknowledge that in general it is the responsibility of the building owner to procure the insurance. The policy would be written in the name of the property owner, not the property management firm, unless there is some type of contractual relationship between the building owner and the property manager.

The point is, said Fricker, "you have to look at insurable interest. The primary insurable interest rests with the property owner."

Risk Management's Kurdziel agreed that the "other insurance" clause can be a real problem for property managers if not handled properly. He suggested that this was one more reason for property managers to look into some form of professional liability or expanded Director's and Officer's coverage.

"Both insurance carriers and property owners are looking more and more to the property manager," Kurdziel said. "To a certain extent it's a care, custody, and control issue: Who is really controlling the property? Is the property owner supposed to pay for the problem, or should the property management firm be responsible?"

For Kurdziel, the only appropriate venue to solve such disputes is up front in the contract negotiation process. "If I were the property owner," he continued, "I would certainly want to have the property managers be responsible and have them carry coverage rather than me carrying the whole burden. But, of course, that is going to be reflected in their rates to me for managing the property. So it needs to be worked out on both sides."

Small claims equal big issues

One more result of a hard market is the tendency on the part of some insurers to be less forthcoming with settlements than they might have been when the market was soft. In addition, property owners and managers may find themselves placed under greater scrutiny by insurance companies to keep the properties well maintained and thus in lower risk categories.

"I've noticed the insurance companies seem to be watching the properties a bit closer," said Biga. "It's forcing the owners to be more realistic about potential risk and about trying to reduce those risks."

Biga also pointed out that in his experience, insurers only want to pay about half the amount on claims. If you send them a claim for one dollar, they only want to pay fifty cents.

Hersh added that the problem with such behavior is that most property owners and managers are then faced with two types of claims: small claims, referred to as frequency without severity, caused by such events as wastepaper fires and "slips and falls"; or big claims such as an entire building burning down. "There's not much in between," Hersh said.

What you need, according to Hersh, is a carrier who can do the following:

* Deal quickly with small claims so they do not get out of hand.

* Be able to work with you on the big claims to settle them for a reasonable amount and on a reasonable schedule.

Of course, this requirement gets back to the previous issues of the willingness of a company to insure in a particular area, the risk level of the property in question, and the overall stability of the insurance company based on its past losses and the underlying health of that company's reinsurers.

Getting a good agent

Although it may sound almost simplistic, the one thing that nearly everyone agreed on was the importance of finding and becoming comfortable with a knowledgeable insurance agent.

According to Hersh, "Unless you're a firm big enough to have somebody who is doing insurance all the time, which next to nobody is, you've got to have somebody who can read all the literature, stay in touch with changes at the insurers, and evaluate the situation according to your specific needs."

In many situations, Hersh believes that the best person for that job is an insurance broker or agent. "In a hard market," he continued, "you're not asking your broker to go out and place insurance. Anybody can do that. You're asking your broker to tell you enough so you can spend your insurance dollar very wisely."

A New Form of Renter's Insurance

One new development in property insurance that can potentially have a significant beneficial impact on a property manager's bottom line is the recent introduction of prequalified property and liability coverage for residents.

One such product was developed by the Risk Management Group of Atlanta, in association with Cigna Insurance. A number of Post Properties condominium projects in the Atlanta area were used as a real-world testing ground.

According to Risk Management president Bob Kurdziel, the primary benefit of the program is that by giving each resident a high-liability coverage for his or her individual property, the amount of coverage needed by the owner and manager can be reduced.

The problem to be addressed, according to Kurdziel, is that owners and managers can incur significant costs if they have to pay out-of-pocket expenses or if residents file claims against the owner/manager's insurance for their personal property, liability, or medical losses. The preferred alternative is for tenants to carry their own insurance.

The standard coverage under the prequalified plan is $300,000 liability for each resident, with provisions for waterbeds, full replacement costs for claimed items, and so forth. "It's essentially a high-end homeowner's type coverage without the real property being covered," said Kurdziel.

In addition, the resident's policy can be endorsed for personal valuables "as high as they want to go."

Premiums are included as part of the resident's monthly rental fee. Kurdziel prequalifies and preunderwrites the property so all residents automatically qualify. They can apply at the time they move in or at any time during the course of their lease.

Robert Bruce is a freelance business writer based in Newberg, Oregon.
COPYRIGHT 1993 National Association of Realtors
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Title Annotation:includes related article
Author:Robert I, King of Scotland
Publication:Journal of Property Management
Date:Jul 1, 1993
Previous Article:Lessons from the inferno: emergency preparedness at the World Trade Center.
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