April 24, 2002

Commercial Mortgages & Real Estate Loans:
Insurance costs!

Insurance costs! The last time we addressed the issue of rising insurance premiums, the dust was literally settling from 9/11 and we were doing our best to speculate about the effects of terrorism on an already hardening insurance market. This time, Melanie Ransford, President of Doell & Associates, gives us her take on what she's seeing in the market place and how it translates to the commercial real estate industry. Doell & Associates is a full service property & casualty insurance brokerage, specializing in multifamily and commercial property accounts. They have full access to the worlds' leading insurance carriers and represent clients across the United States. Given the broad reaching implications of higher insurance costs to commercial real estate investors and the economy at large - this issue is receiving considerable attention from consumers all the way up to the Bush Administration.

Ms. Ransford reported that the first quarter of 2002 saw renewal increases of anywhere from 20% - 50%, but indicated the trend to increase commercial premiums will drastically slow down in 2003. She said, "Huge increases have had a crippling effect on businesses of all sizes and insurance companies are being forced to change their hard-line stance." As we are painfully aware, increases in insurance costs not only hit investors on the "bottom line", but also directly translate to a reduction in overall property valuation and the amount of leverage an asset can support with commercial mortgages. However, there are two important factors helping to rein in runaway insurance costs: 1) a proposed federal safety net to cover future terrorist attacks, and 2) buyer discontent and unwillingness to tolerate further increases.

With regard to the proposed federal safety net, the Los Angeles Times reported, "Insurance payouts from Sept. 11 attacks are expected to range from $30 billion to $70 billion. Under the House measure, when claims from a future attack exceed $1 billion, the government would cover up to 90% of the losses, up to $100 billion. The government would recoup its money from an assessment on insurance firms and perhaps a surcharge on policyholders. The measure provides the protection for the next year, with a possible extension for two years."

The other factor working to curb rising commercial premiums comes directly from the policyholders. As reported in a March 25, 2002 edition of Business Insurance, "large national and global buyers are anything but tolerant, and are preparing to abandon the traditional insurance market and use alternative commercial risk financing options. This exodus from the traditional market will prompt a flattening of mortgage insurance rates over the next two years, with rate increases for larger corporate buyers dropping toward the single-digit range for 2003." There are alternatives to traditional insurance coverage and some large companies have begun to choose alternative risk transfer solutions when the methods are economically feasible. These alternatives include:

Self-insurance - Self-imposed savings earmarked for potential loss situations normally covered by conventional insurance policies.

Captives - An associated group or single owner, who has chosen to retain a substantial portion of each loss and then purchase reinsurance for losses that exceed a set limit. Due to operating expense and capital requirements, this option generally attracts organizations whose premiums exceed $2 million.

Risk Purchasing Groups - A group of insureds engaged in similar businesses or activities who unite to purchase insurance coverage from a commercial real estate insurer. In many cases the limits purchased are higher, but losses reduce the coverage of the group.

Most property owners view insurance coverage as a necessary evil, and lately rising costs have been exceptionally glaring. Fortunately, there appears to be relief on the horizon, with federal involvement as well as the natural effects of a competitive marketplace. Commercial real estate investors, large and small, will likely see premiums begin to stabilize once again - and that's good news.

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