Insurance Costs Effects on Real Estate
By Omar Ruiz
Insurance costs effects on real estate have been dramatic over the last several years. Owners of properties throughout Texas have been dealing with increasing premiums that exceed norms of 5-10%. The majority of our real estate portfolio is in the state of Texas. Despite never needing to file a claim on our Texas properties, we’re feeling the annoyance of increasing premiums. These insurance costs effect real estate operations, causing adjustments to underwriting models for acquisitions. We pride ourselves on our robust due diligence practices that include considerations for natural hazard risks, such as flooding. It’s helped us avoid major weather issues, even when other areas suffered severely. In conversations with real estate brokers and insurance providers, I’ve learned it’s affecting other states and also why it’s happening. I believe it will be a trend moving forward that will likely affect some properties more than others.
What’s Been Happening?
Several years ago around 2019/2020 our company noticed insurance premiums on a property we own in Houston Texas increasing at a higher rate than normal. We understand Houston TX is known to get severe storms and repetitive floods. However, our property is not in a flood zone and has avoided every flood that’s hit the city, due to its elevation. We were confused why our premiums increased so much, especially since we never filed a claim. We’ve worked with a good insurance broker for over 10 years. She’s always been competitive, until 2022 when we made a change on another property. Despite her best efforts, she couldn’t compensate for major insurance industry impacts causing ripple effects.
About a year later the same rate increases occurred on another property. This property is located on the opposite end of the state with fewer storms than in Houston (hours away by plane). We never filed any claims on this property, but it’s a larger property and the increases were even higher (20-40% depending on quote). We talked to several different insurance agents that scoured their sources and we’re forced to change in 2022 – although still at a higher premium. Now there are fewer insurance carriers, and most brokers already work with the same carriers so the options are limited.
What’s the Cause?
I asked my network of brokers in the Midwest region of the country and discovered insurance costs effects on real estate impacting landlords there as well. It’s the same issue of premiums increasing higher than normal. The reason is something known as “shock losses” in the insurance industry. The new insurance broker we’re working with in 2022 informed me that a major carrier named Strata (who we’ve had before) experienced shock losses. Shock Losses are when an insurance company has to pay big claims, but they may be isolated/infrequent events. These shock loss events linger for a while as they appear on loss run reports. A loss run report is a record of claims on a property for any given year. When a new policy is quoted the insurance agent will ask for a loss run report, typically going back 2 years. Recently they’ve been going back 3 years. If a property has a claim recorded, then it will be a factor in the amount of the premium.
The shock losses caused Strata to lose their reinsurers backing. Reinsurers provide financial support to insurance companies by handling risks that are too large for insurance companies to handle by themselves. The reinsurers receive a part of the premium for this support. They help spread the risk of insuring natural disasters and prevent the primary insurer from going bankrupt. They help insurers (like Strata) get more business and make it possible for them to reserve less capital to cover potential losses.
According to the insurance guy and a Dallas broker, the 2021 North American Winter Storm played a major part in insurance costs effects on real estate. The winter storm caused power outages to the Texas energy grid and even left snow on the beaches of Galveston Texas in the Gulf of Mexico. The storm caused Strata to payout the highest amount of claims in history – shock losses. Part of the issue was the plumbing systems susceptible to extreme cold weather. Unlike in the Midwest where builders are used to extreme cold, there’s a preference for pex plumbing; a type of plastic tubing made of polyethylene. The material is more freeze resistant than rigid copper pipes. When the winter storm hit and the Texas energy grid went down, properties became vulnerable to water freezing in copper pipes, causing them to burst. This unforeseen event caused numerous claims and shock losses. As a result insurance costs effects on real estate crippled Strata and the reinsurers.
Video of Lady Still Dealing with Burst Pipes from 2021 North American Winter Storm
We had pipes burst on a property in Galveston; however, it was easily handled without filing a claim. Our other properties didn’t have issues but premiums still went up. The insurance broker explained there is a “lack of capacity”, meaning less carriers want to participate in certain areas. There were around 20 insurance carriers but now it’s down to 10 as Texas is considered a “storm state” – similar to Florida. Insurers participate in areas where more properties exist to have a viable business and insure properties in lower density states. States like Oklahoma and Arkansas don’t have enough assets to spread losses for insurers; therefore, Texas with its many property assets helps maintain their business. This is the reason that despite us not filing any claims, our premiums still increased. As new insurers enter an area they command higher costs. Insurers also tightened their underwriting and increased the square footage amount for replacement cost calculations.
Other Events Cause Major Insurance Costs Effects on Real Estate
2021 was a difficult year for insurance companies across the country. Florida especially had a regularity of natural disasters that have claims yet to get closed-out in the insurance market. Compounding Florida’s insurance costs effects on real estate was the Surfside Condo collapse in Miami. The unexpected collapse by decades old deficient construction caused the deaths of 98 people. Insurance companies dealing with claims from the collapse are also dealing with adjacent buildings. This has “never happened and it’s a new category” according to the Wall Street Journal. Local government leaders ordered the audit of high-rise buildings older than 40 years and a flurry of engineering inspections. The governor signed new laws requiring stricter inspections and increased costs for new developments of high-rise buildings. The increased insurance costs are reducing profits for developers and delaying or canceling new construction projects.
The shock losses together with the typical number of claims insurance company’s process on average; it becomes clearer that insurers are in difficult times and on high-alert to mitigate risks. Insurance costs effects on real estate are going to continue having an impact. Mortgage lenders are consistently inquiring about insurance costs on new purchases to make sure borrowers can absorb increases and pay the debt.
What Can We Expect in the Future?
The next several years will continue to bring increases in insurance costs. Insurance costs effects on real estate will be among the most scrutinized expense item for underwriting of new acquisitions. It will take around 3-4 years of hopefully calm periods before these shock losses stop appearing on loss run reports. Then insurers will begin competing for business and settling down on their premium increases. If the future brings more catastrophic natural disasters, then landlords will continue feeling the hurt of increasing premiums. Buyers will need to carefully consider increasing insurance costs on new purchases. The result may be further pressure on prices moving forward.
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