publisher’s Note: This article is the final in a four-part series from Zurich North America and focuses on current and historical trends in the commercial real estate space. Previous articles checked commercial auto insurance, general liability and workers’ compensation.
Looking at near- and medium-term factors that will continue to affect commercial property insurance markets in the coming year, it is clear that insurers, brokers and customers will continue to feel the effects of inflation associated with more costly natural catastrophes. While there is no general agreement as to whether the pace of natural disasters represents a greater frequency, there is no doubt that the impact of these events is amplified as more occurs with increased commercial and industrial development in regions where severe weather has not occurred Values are uncovered as great impact in the past.
The growth in property at risk from natural catastrophes is further complicated by an environment of rising inflation, affecting replacement cost covers in commercial property insurance contracts. Simply put, if the values to be insured are outdated and have become significantly undervalued due to inflation, this can create unpleasant surprises at the time of loss and impact insurers’ ability to allocate capacity on renewal.
The value of accurate reviews
Each February, Zurich North America publishes a report compiling replacement cost trends. Our recently released 2022 report finds that current construction cost trends show an unprecedented rise in construction cost inflation for the year ending January 2022, with an average increase of over 12% for the year. Regionally, costs increased by 10% to 15% depending on local conditions.
For underwriters, inaccurate pricing is more than just a premium-impacting issue. Accurate values are fundamental to overall risk assessment, capacity allocation, reinsurance decisions, setting floors and deductibles, and natural catastrophe modeling. Underwriters typically pay close attention to annual changes in value to assess how customers are responding to their value claims and to what extent their claims support the insurance terms provided.
Proper monitoring and reporting of values is also in the best interests of customers. Risk managers need to ensure they have adequate insurance for the assets they are exposed to and that there are no surprises at the time of reporting a claim. If the renewal ratings for an account that has not seen the addition or disposal of insured locations have remained relatively unchanged over a number of years, the rating is likely misaligned and needs to be addressed.
For this reason, we recommend real estate clients have a program in place to ensure they are continually managing value statements to not only account for the addition or removal of locations, but also to account for the impact of inflation and other factors.
It’s about the rising costs of everything needed to replace part or all of a facility when it fails – from building materials and labor to the cost of new equipment and restoring inventory and materials. At a time when inflation was hovering around 1%, its impact on values and replacement costs may have been within acceptable limits. However, in a high-inflation environment, the impact on replacement costs is significant and the potential for underinsurance is real.
The issue of valuation is further complicated in disaster-prone regions by the fact that thousands of insured businesses are seeking construction and professional services, such as roofing and other trades, to start repairs on their properties at the same time. As a result, labor and material costs will increase significantly, anywhere from 10% to 15%, directly impacting loss costs. Additionally, increased costs associated with updated building regulation requirements may come into play when facilities are remodeled to current standards.
Obviously, customers understand the need to update new and decommissioned sites, but are they also aware of what goes into replacement costs? Do you have a process to determine the costs annually? Do they work with a third party to help them determine their replacement cost through appraisals or appraisal services? Are their sources of information reliable and are they adequately keeping pace with cost developments? Are they aware of the inflationary and supply chain pressures that can affect one region or area or their respective occupancy more than others?
As previously mentioned, the impact of outdated assessment reports can be compounded by the potential for increasingly destructive and costly natural disasters. According to the National Oceanic and Atmospheric Administration (NOAA), the US experienced 20 separate billion-dollar weather and climate disasters in 2021, ranking second last year for most disasters in a calendar year, behind a record of 22 separate billion-dollar weather and climate disasters Events in 2020.3 And the variety of natural disasters in 2021 also made it a standout year. In addition to Tropical Cyclones Elsa, Fred, Ida and Nicholas, a host of severe weather events swept the country including:
- A winter storm/cold wave event in the Deep South and Texas.
- Wildfires in Arizona, California, Colorado, Idaho, Montana, Oregon and Washington.
- An ongoing drought and heatwave in the western United States
- Major floods in California and Louisiana.
- Three particularly devastating tornado outbreaks and a powerful derecho storm swept through the Midwest in December.
These types of events are often referred to by insurers as “secondary perils” to distinguish them from the primary catastrophic natural perils of hurricanes and earthquakes. These primary hazards are the ones most expected to cause massive property damage and financial loss, but designating the broader range of natural hazards as secondary hazards in no way diminishes their growing threat. Hail, tornadoes, floods, wildfires, stronger convective storms, extreme heat and cold, and other secondary hazards are becoming increasingly dangerous and costly, complicated by changing weather patterns that are changing the character of natural hazard risk in some regions. Tornadoes, for example, occur in parts of the country well outside the traditional “tornado avenue.” And “100-year” and “500-year” floods due to heavier rainfall attributed to climate change are occurring more frequently than their categorization would lead us to believe.
Recent climatological history suggests that customers need to focus much more on the exposure they may have to all evolving natural hazards, rather than just the potential impact of such critical disasters as hurricanes and earthquakes. Customers need to understand the options available to make their businesses more resilient. This could mean modifying defensive structures such as flood barriers and water diversion techniques to mitigate flood losses. In the event of a wildfire, procedures should be in place to shut down HVAC systems to protect against smoke damage and contamination, among other safeguards.
The Value of Collaboration
Like most business trends, the current pressure on property insurance rates and capacity, driven by the tag team of rising inflation and costlier natural catastrophes, will eventually achieve stability and balance. A greater focus on collaboration between customers and insurers to improve corporate resilience and sustainability by mitigating evolving climate risks will pay off going forward. Inflationary pressures will ease, as they always do in our dynamic, resilient economy. Right now, the top customer need is to ensure property valuations are up to date and to better understand what their valuations are meant to represent.
Customers should consult with their brokers and underwriters for a clearer understanding of the impact current trend lines are having on property insurance and why accurate valuation statements are an essential part of a successful program. We are indeed all united, and together we can meet the challenges of an evolving real estate market to ensure all businesses have the risk management programs, support and capacity they need for the future.
Alex Fountain is Head of US Middle Market for Zurich North America, where he is responsible for the focused focus and oversight of our investments in redefining and profitably positioning our Middle Markets business.
This article originally appeared on the Zurich North America website and is reprinted here with permission.
The opinions expressed here are those of the author.