Shocking! What’s Really Driving Up Insurance Costs? Learn the Hidden Truth Behind Policy Pricing
Real Estate Part 3: Navigating the Intricacies of the Insurance Market
There's a very, very fine balance between the combined ratio, investment income, and the actual risk that insurance carriers face. So, carriers are really, really trying to thread the needle to get this risk-reward analysis just right.
Understanding Residual Markets
What is a residual market and what are some examples of them? There's a misconception about how insurance carriers operate, and oftentimes, several insurance markets are really overlooked. These overlooked markets, known as residual markets, are considered the markets of last resort. This doesn't necessarily mean they're the most economical, but it does imply that if you're in a tight spot and need insurance, residual markets have got you covered.
For instance, California has "Cal Quake" for earthquake coverage. Other options include the Cal FAIR Program, which provides property and casualty insurance for businesses. The State Fund for workers' compensation is another residual market option, especially for new businesses without an experience mod or those with a high experience mod.
Residual Market Options Across States:
California
Cal Quake
Cal FAIR Program
State Fund for Workers Comp
Texas
Texas State Wind Fund
Florida
Comparable state-specific options
These markets ensure that if you're in an area historically difficult to insure due to catastrophes or fires, you have an option. While these markets can be manually intensive to get quotes, often the pricing isn't bad.
Key Exclusions for Insurance Adjusters to Consider
When purchasing new insurance policies, it's crucial to do a comparison beyond just the price. Particularly on the liability side, we must consider what’s excluded from coverage. Some common exclusions include:
Abuse - Sometimes combined with sexual abuse and assault
Battery
Habitability
Animals
Infestations
Mold
Construction Activities
Why It's Important:
"If something does happen, are we adequately covered? Are we going to be covered at all?"
Being aware of these exclusions helps ensure you aren’t left uncovered in the event of a claim.
How Do Insurance Companies Make Money?
There's a general misconception about how insurance companies turn a profit. The prevailing belief is that they collect premiums and let the money sit there. However, that's far from reality. They focus primarily on the combined ratio, measuring both underwriting and investment profitability.
The Combined Ratio:
Underwriting Profitability: Expenses from losses, overheads, broker payments.
Investment Profitability: Dollars from premiums invested in stable opportunities like CDs and treasuries.
"The overall goal for a combined ratio from an underwriting standpoint is really to try and aim for 95 to 90."
This essentially means that for every dollar of premium written, the net profit is five to ten cents.
Impact of Catastrophes:
Due to catastrophe losses, insurance companies rely heavily on investment returns to bolster profitability. Despite market conditions improving, insurance carriers are very restricted in their investments, emphasizing stability and liquidity.
What is the Excess Surplus Market?
With many clients moving from direct retail markets to the excess surplus market, it's critical to understand the difference. Excess and surplus lines provide coverage where direct admitted carriers cannot, usually due to uniquely risky investments or geographies.
Implications of Excess and Surplus Markets:
Higher Rates & Tighter Coverages
Stamping and Surplus Lines Tax
Upfront Payment Requirements
Being unable to utilize payment plans or enjoying state-guaranteed fund backing (unlike admitted carriers) adds layers of complexity.
Is the Lack of Insurance in Communities of Color Redlining?
In metro areas with higher crime scores, often inhabited by people of color, insurance carriers are more particular about providing coverage. This raised concerns about modern redlining practices, mirroring historical trends where companies discriminated based on demographics.
Factors Contributing to Discrimination:
Rationales beyond affordable housing or income levels are used to deny coverage.
Legislation regulates against direct discrimination but doesn’t stop indirect methods.
"There is inherent discrimination in the underwriting process, as the essence of underwriting involves risk differentiation."
To tackle this, a deeper audit of trends and transparency in underwriting decisions is necessary.
Pollution Coverage for Real Estate Investments
For condo and affordable housing investors, pollution coverage extends beyond just environmental policies. General liability policies often exclude:
Mold
Legionella (water contamination)
Importance of Pollution Policies:
These policies can cover property damage, lost income, and health impacts, making them crucial for investors.
Urban Infill Projects: Site Security Concerns
Investing in urban areas like Oakland, New York, and Miami involves addressing high crime scores. Insurance carriers are particularly concerned with the risk of arson in these projects.
Site Security Measures:
From cameras and fencing to on-site security, measures to mitigate risks can significantly increase project costs. These costs, combined with builders' risk insurance, are crucial to consider for any urban infill project.
The Role of Risk Purchasing Groups (RPGs) in Affordable Housing
New legislation suggests alternative ways for affordable housing insurance, such as captives and risk purchasing groups. RPGs, unlike insurance companies, consist of members taking on risks. While traditionally used for third-party liability, RPGs could potentially extend to property insurance, provided:
Concentration of Risk is minimized.
Geographical risk factors are carefully considered.
Understanding MOU Insurance Costs
When evaluating an MOU, it's critical to anticipate potential disparities between estimated and actual insurance costs. For example, a current cost of $400 per door could escalate to $750 or even $1,000 per door after underwriting.
Earthquake Sprinkler Leakage Coverage
Even without earthquake coverage, most property policies include earthquake sprinkler leakage (EQSL). This coverage is essential due to the potential water damage from leaking sprinklers after an earthquake.
"EQSL is a highly important coverage. It’s likely that these sprinklers will leak, causing major water damage."
Ensuring you have this coverage can mitigate significant losses from even minor earthquakes.
Conclusion
Navigating the complexities of the insurance market, especially in real estate, requires an in-depth understanding of various factors— from residual markets and excess surplus lines to discrimination concerns and pollution coverage. By paying attention to these aspects, investors and insurance professionals can make informed decisions that safeguard their investments and operations.
Stay informed, stay covered, and always balance the risk-reward intricacies unique to the insurance world.
Thank you, Jonathan, for this beyond insightful conversation on insurance that truly goes beyond the basics.
