Author: Jon Barron
Since the 2017-2018 California wildfires, the US Property insurance market has been under increasing pressure from extensive losses, depleting available capital. This pressure, coupled with rapidly escalating reconstruction costs and higher interest rates, has significantly raised property ownership expenses. This increase, in turn, has impacted today's real estate market, making older buildings more accessible at discounted prices.
Before finalizing a purchase, it's crucial to understand the current insurability challenges, potential pitfalls and steps for identification. These insurability issues often push the building into a high-risk market that offers skeleton coverages at multiple times the normal cost.
Here are 11 factors that affect how insurable a property is.
1. Electrical safety
Outdated breaker panels, like ones prevalent 40 to 50 years ago, can compromise insurability due to a high risk of fires and reinsurers' reluctance. Ensure the electrical system meets current safety standards. Many electricians may vouch for their safety, but almost all insurers shy away due to a track record of over 2,000 fire-related incidents annually.
2. Lack of sprinklers
Residential spaces above the second floor without a building-wide sprinkler system pose a significant risk. Since insurers prioritize life safety, assume no (affordable) insurer is able to insure a building with without sprinklers. Few, if any, exceptions exist.
Sprinklers greatly increase people's chance of survival in case of a fire. Sprinkler systems are more of a life safety issue, but sprinklers do greatly improve insurability.
3. Vacancy rules
Insurance policies typically require at least one-third of the space to be actively used. Use of less is still considered vacant by many definitions. Extended vacancies, often 30 days or more, may require special policies due to increased risk of losses due to vandalism, squatters, fires and water damage.
Areas with high risk of wildfires or convective storms (wind and hail), and even remote locations can be terribly expensive to insure the property, often 11 times more expensive than lower-risk locations.
Most policies exclude coverage for construction-related losses, typically after 30 days. Insurers may also have underwriting thresholds for scope and cost of the project.
This subject can get complex quickly, especially if you're hoping to continue normal operations in the same building during construction. Discuss early with your broker and plan accordingly, especially for major construction work. Any piercing of roof, welding or structural work is usually considered major work that needs some special attention. Many underwriters also consider a project over $200,000 to be major.
6. Environmental liability concerns
When dealing with potential environmental liabilities (aka pollution), conduct thorough due diligence to assess and manage risks effectively. Environmental liability can be hidden in (or under) a building, on vacant land, or even be brought to your premises by a contractor. Insurance and non-insurance methods can manage this risk.
7. Building condition
The age and condition of a building can affect insurability. Ensure necessary repairs and maintenance to meet insurer requirements. Habitability conditions should be excellent when housing people. There is a rapidly rising trend of lawsuits with seven-figure judgments against housing providers regarding habitability concerns.
8. Unrepaired damages
Unrepaired damages and significant deferred maintenance can jeopardize insurability. Prioritize repairs.
9. Prior claims history
Underwriters have access to so much information for their own research, but they never tell us what they know. However, they do match it up against the info your broker provides.
It's better to know the history and address any issues proactively. If acquiring a building, request a loss history report from the current insurers for all insurance lines. Ten years is ideal to highlight issues or loss patterns needing attention.
10. Building design and risk management
For many organizations with low losses, part of the recipe for success is building community and developing a supportive culture. In the building design, a centralized entrance and central gathering spot are important ingredients in the recipe.
So, while old motels are cheap, the come-and-go atmosphere of the exterior single-room occupancy (SRO) is hindering good community and development of a supportive culture. Similarly, apartment buildings need a centralized entrance with gathering space and a place for staff and volunteers to connect with residents to build solid relationships.
This central area isn't just a catalyst for developing community, but also for identifying problems and challenges before they escalate to huge issues. The resulting insurance losses related to SROs have caused most underwriters to completely stop insuring these buildings.
From the perspective of insurance companies, underinsured properties pose a higher risk. Underinsurance can also erode trust between the property owner and the insurance company. Certain insurance brokers have the expertise and capabilities required to produce a replacement cost report, which aids in preventing the acquisition of either inadequate or excessive insurance coverage. Alternatively, you can enlist the services of an experienced appraiser to create this report and account for claims trends and valuation lags. A prevalent misconception is assuming that the purchase price serves as the appropriate insurance limit.
To navigate building insurability challenges before purchase, involve your insurance broker early. Explore and discuss these factors to gain valuable insights and guidance. In many cases, the allure of discounted properties or generous contributions may mask hidden operational and maintenance costs. Thorough preparation and management are key to securing insurability in today's market.