At a glance:
- North American buyers are facing a shortage of insurance options and skyrocketing premiums in many markets.
- Rising insurance costs are calling attention to the increased frequency of adverse climate events happening around the globe.
- For CRE owners, solutions abound to mitigate risk across property or portfolio.
How rising insurance rates are impacting owners of commercial real estate across North America
Buyers are unexpectedly challenged closing deals because of a shortage of insurance availability and skyrocketing premiums, especially in areas with increasing exposure to climate risk.
Across North America, commercial property insurance is increasingly expensive and challenging to obtain. Once a box-checking exercise, securing insurance has become a complex and prominent part of the deal consideration process.
Commercial property insurance rates in the U.S. rose by up to 150% in 2023 year-over-year, according to USI. Internationally, rates rose by up to 30%. High-risk areas plagued by extreme weather events saw the steepest hikes. In some cases, insurance in Florida, especially near the coasts, is not available at any price. Since 2022, three insurance companies have withdrawn from the state. Fifteen other carriers are not issuing new policies in Florida. Similar trends are becoming prevalent in fire-prone regions in the West.
“Insurance carriers are determining where it’s better to lose business and back away than payout losses,” said William Fay, CIC, a Miami-based client advisor at World Insurance Associates. “And it’s only going to get worse.”
The canary in the coal mine
U.S. 2023 Billion-dollar weather and climate disasters
Figure 1. In 2023, 28 separate weather or climate disasters in the US caused at least $1 billion in damages, Source: U.S. National Oceanic and Atmospheric Administration, 2023
What’s behind the increased insurance costs? While litigation, inflation, and valuations are all factors, climate change is also a major contributor. As extreme weather events become more frequent and powerful due to rising global temperatures, compounded by the loss of natural habitats like wetlands, insurance companies pay more in claims. This leads to increased costs for insurers, who pass them on to policyholders.
“Insurance is the canary in the coal mine signaling rising climate risks,” said Amy Erixon, who leads Avison Young’s Global Investment Management practice. “Insurance has been, by its nature, backward-looking, but the industry is trying to get more proactive about anticipating and pricing in climate risks.”
Claims costs paid by insurers rose 30% year-over-year in the first half of 2023, according to Swiss Re. $54 billion of catastrophic losses occurred during that period, with nearly 70% of the losses attributed to 10 severe convective storm events in the U.S.
“Storms are dynamic, unpredictable, and highly location-specific,” Erixon said. “One storm can sweep through an area with myriad tornados missing major targets while the next similar storm is less fortunate and takes out hundreds of properties.”
Costs of extreme weather: Catastrophic insurable losses
Figure 1. Catastrophic insured losses that caused at least $25 million in claims associated with extreme weather in Canada, 1983-2022, Source: The Intact Centre on Climate Adaptation, 2023
What does this mean for commercial real estate?
Commercial owners are feeling their margins squeezed by increased premiums. Virtually all (98%) multifamily executives recently surveyed by the lender Lument said that insurance costs were an issue for their companies. And most (95%) net buyers said that insurance costs could prevent them from making acquisitions.
Even properties in relatively low climate risk areas are experiencing higher insurance costs due to “bundled” insurance spreading risk across various assets, including those in high-risk zones.
In November 2023, Erixon and other principals at Avison Young Investment Management (AYIM) learned this firsthand. They were expecting a relatively frictionless close to their purchase of a 200-unit multifamily property near Winnipeg. At the last minute, they were surprised to find that no single insurer was willing to provide coverage—at any price.
Erixon called the situation “baffling,” especially given no recent disasters had occurred in the region.
“Winnipeg is not a particularly climate-exposed location,” Erixon said. “The biggest problem with the weather in Winnipeg is that it gets brutally cold in the winter.”
Erixon and her team enlisted seasoned insurance brokers to find a solution to bind the policy. A week later, they were able to secure coverage—but since no insurer could offer blanket coverage, the risks on the $50 million deal had to be split amongst four different local insurers who each covered a quarter.
“The Winnipeg example underscores the universality of the insurance issue,” Erixon said. “It’s not limited to climate-exposed regions.”
What can CRE owners do to mitigate the risks?
“Insurance is often considered the first line of defense against physical climate risk,” Erixon said, noting that the final line of defense is relocation and/or divestiture. “Between these two poles, there are thoughtful things that investors and occupiers can consider, such as undertaking careful due diligence review of regional climate exposures and recent insurance trends and determining whether local and state governments can underwrite the hardening of infrastructure to defend against losses, including loss of power and/or water,” she said.
Here are just a few more steps owners can take:
Retrofit properties for resilience: Owners can consider preventative investments in retrofits that increase building resiliency to reduce risk. According to FM Global, “For every $1 a company spends to protect structures from hurricane, wind, and flood damage, estimated loss exposures decrease by an average of $105 due to a reduction in the risk of property loss and business disruption.”
Utilize discounts, loans, and incentives: Retrofits can be expensive, but the use of incentives, grants, and insurance savings programs can curb costs. Here are just a few of the programs that incentivize resilient retrofits:
- HUD Green and Resilient Retrofit Program (GRRP): The United States Department of Housing and Urban Development (HUD) funds retrofits in multifamily assisted housing properties to improve energy efficiency and resilience against extreme weather.
- NYC accelerator Property Assessed Clean Energy (PACE): This financing tool helps commercial building owners fund energy efficiency retrofits, including roof replacements to install wind-resistant and hail-resistant materials, upgrades to make exterior cladding stronger with resilient materials, and the installation of impact-resistant windows and doors. It offers long-term, fixed-rate financing, covering up to 100% of project costs.
- Insurance Discounts for Retrofits: As losses from climate events mount, many insurance providers offer discounts to owners who harden their properties, allowing them to recoup some of their retrofit investment. The U.S. National Flood Insurance Program (NFIP) discounts premiums for various flood mitigation measures.
Bundle risk: When a property is in a high-risk location where insurance is expensive or unavailable, owners can “bundle the risk,” grouping the high-risk property with other lower-risk properties and insuring them together, said Michael Fay, Chairman of the U.S. Capital Markets Group at Avison Young. For example, an owner could bundle a property in Miami, where insurance is expensive and complicated to obtain, with properties in Maine, a state that WalletHub ranked as least impacted by natural disasters in 2022.
“Bundling spreads the risk across multiple properties, reducing overall insurance costs,” Fay said. “It works best for diverse geographic portfolios. A client with four assets that are all in Florida can’t bundle.”
Layer Coverage: Since the catastrophic Hurricane Andrew hit Florida in 1992, layered coverage has become critical for insuring commercial properties valued over $2.4 million, particularly in high-risk areas, said Fay.
“Struggling under the weight of Hurricane Andrew claims, insurers either shut down or added more exclusions and limitations to their coverage,” he said.
From then on, due to soaring claims, insurers have limited how much of a property they would cover, especially for windstorm damage.
Given that this trend could worsen, it’s imperative that buyers work closely with insurance advisors to “peel back the layers of coverage and make informed decisions about what coverages to layer or self-insure,” Fay said.
The foundational layer of coverage is often the most expensive as it is the first to payout losses. Take, for instance, wind coverage—one of the hardest and priciest to secure. If an insurer agrees to cover only the first $2 million for a $5 million property, additional layers of insurance can be stacked to reach the total value.
“It’s vital to work with an agent who provides insurance market updates and annually markets the entire program, as that avoids any last-minute surprises and ensures you’re still getting the best offers and using the right layering methods,” Fay said.
Preparing portfolios for the future
While markets are full of challenging conditions right now, it’s important to note that these are problems that, fortunately, we can do something about, at least at the portfolio level.
It might mean less availability of insurance in the near term for some locations, but solutions to consider other locations, bundle, practice better due diligence and other options provide opportunity to act.
The first step is taking a hard look at what you’ve got and where, and then to start reassessing what the best moves are right now across your assets.
This article is part of our 2024 Drivers of Change series where we explore the factors impacting our cities and places, and propelling us forward to adapt, learn and take advantage of the opportunities they present. See all the 2024 Drivers of Change or subscribe to be notified when new Drivers of Change are released.
For more information, contact:
-
Principal President, Global Investment Management
-
Investment Management
-
Chairman, U.S. Capital Markets Group Executive Committee, Principal, Managing Director - Miami
-
Capital Markets Group, Consulting & Advisory, Investment Sales