October 2024 Newsletter
Insurance Deep Dive
If you’re engaged in this business or you’re an investor, you know that insurance has been rough. Rough for the user, but also rough for the insurer. If you live in the San Francisco Bay Area, like many of our investors, you’re seeing it firsthand with the difficulty of insuring your home due to wildfires. And while we don’t count many Floridians among our investors, I can only imagine the challenge of securing insurance on any property in Florida right now.
Here's a sobering statistic from the Insurance Information Institute, which found 12% of Americans no longer have home insurance, up from 5% in 2019.
Over the past month, we’ve seen significant changes in the insurance market for commercial real estate, as well. Premiums for some of our buildings have risen 40-50% per year over the last 2 to 3 years—an increase nobody, including us, underwrote for when acquiring these properties.
Then, I got a text from a good friend and fellow operator last week:
“Did you hear the AmFam news? They’re non-renewing all multifamily properties - getting out of the space completely.”
That was a gut punch. We use AmFam on many properties, and now we’re faced with a long, exhaustive process to find a replacement.
But why? We haven’t had significant claims or damages across our portfolio.
The reality is that insurers are facing billion-dollar losses due to events like buildings burning during the social unrest of 2020-2022 and the increasing frequency of major storms. What used to be considered a “once-in-a-decade” weather event is now an annual occurrence. Reinsurance companies, who bear the brunt of these risks, are pulling out—and when they do, the primary carriers follow suit.
This month, I also attended the PNW Multifamily Luncheon, where insurance was a hot topic. After hearing from industry experts and diving deeper into the issues ourselves, we decided to provide our analysis of the current state of the insurance market. Here’s what we found.
First of all – a useful resource. Check out this resource from the US Gov, which highlights “billion-dollar loss storm information” from the US Government.
The 10 Year Storm
This is an inflation adjusted cost of major disaster events – clearly “severe storms” have really picked up in intensity and caused serious losses for insurers. As a resident of the PNW, I’m personally grateful to see “winter storms” not looking that much worse than usual. What’s clearly causing serious loses are “severe storms”.
Below are the losses suffered by “severe storms” by dollar amount, across the entire United States. Clearly Texas, Florida and the rest of the Southeast United States are being disproportionately impacted by this situation. And then, of course, we had the recent severe losses in California due to wildfires, which are also climate change related weather events (of a sort).
To corroborate this point, we researched data on Reinsurance Companies taking substantial losses over the past few years. One of the points made (both at the luncheon, and in conversation with our insurance contacts) is that reinsurance companies are simply not taking on the risk right now.
SwissRE published an article in 2021 highlighting that natural disaster losses were the “fourth highest on record”, and have only gotten worse since. So, you have a majorly increased likelihood of severe weather events as one major cause of insurance spiking.
Replacement Values
The second significant issue is that insurers had, for quite a while, underpriced the cost to replace a building. This was driven, in large part, by the run up in inflation. So, while insurance models were still using old-paradigm replacement costs, the actual cost to replace a building (or do a repair, or or or) had spiked dramatically over the last several years.
And so part of the issue we’re dealing with now is that insurers are now re-setting their premiums to account for this vastly increased cost of replacement. Crucially, replacement costs also increased at a way higher rate than actual inflation. Remember the period where wood, for example, skyrocketed in price? Or appliances – driven by COVID-era supply constraints, sure, but still painful?
All of this feeds into real estate replacement cost, which caused a significant increase in premium required – but crucially, insurers were insuring properties with stale replacement costs, and then finding out that in order to actually replace damaged property the cost was way beyond what they allocated.
Civil Unrest
One other, less frequently quoted issue, is the damage caused by the 2020 Social Unrest issues. Buildings were seriously damaged, and in some cases burnt down, and insurers also bore the brunt of this damage. Those losses are just now working their way through their systems – but they are substantial.
The estimates for 2020 damages range from $1 to $2 billion, with about $500 million in damages in the Twin Cities area alone during 2020. These losses were born by both mainline carriers and their reinsurance companies – and the unhappy result is again that reinsurers are pulling out of the markets, mainline carriers are retreating, and everybody’s premiums are increasing.
The NYT Investigation
Summary
In short, insurance has become a major issue. The solutions are varied, for property investors. To begin with, there’s a substantial “flight to quality” right now in terms of acquiring newer, safer buildings with modern systems. I would suspect another path – for large investor / owners – might be to shift into a captive insurance style model to control cost and protect themselves.
Given we acquire older properties, many of our underwriting models are now tabulating the cost to upgrade needed systems and improve building security to control for insurance cost.
Ultimately, if I had to guess, though – we think the market will sort itself out over time and eventually carriers will return to the multifamily market.
