The Issue of Coverage What's Enough and Why It Costs So Much

After the terror attacks of 2001, many co-op and condo buildings in the New York area got another nasty shock: insurance premiums suddenly spiraled upward as much as 50 percent or more in the space of one or two billing periods. Some buildings were simply dumped by their insurers with little explanation or opportunity for recourse.

A building without adequate insurance is a sitting duck - not necessarily for terrorism, easy as it is to hang all our fears on that vague and ominous possibility - but for everyday mishaps and problems that without proper coverage can turn into hideously complicated, expensive headaches. On top of that, lenders are unlikely to be favorably impressed with a building that stands to lose everything if a grease fire in a shareholder's apartment leads to heavy damages, and that in turn impacts a building's ability to attract shareholders.

So what's the problem? Is it all because of September 11th or is there more to these rising premiums than meets the eye? Who's being affected? How much insurance coverage does a building really need? And most importantly, is this just an unpleasant trend, or are jaw-dropping premiums here to stay?

Consider the Numbers

Any time costs for goods and services increase, there's bound to be a good deal of grumbling, but in this case, it's not necessarily the caprice or greed of huge corporations that's to blame. During the dot.com boom years of the 1990s and the early part of this century, large insurance companies saw huge returns on investments they'd made in the stock market using policyholders' premiums as capital. With funds doubling or tripling themselves between the time they were paid in by policyholders and the time any claims were paid out, insurers could easily afford to keep premiums low - artificially low, according to James Fenniman, ARM, executive vice president of the New York division of Bollinger, Inc., an insurance brokerage and one of the prime movers behind last year's federal reinsurance bill. "You had a market that was under-priced for 10 years," says Fenniman, "and a market that, if you were to take individual rates per exposure units, the rates - even after the escalations of the last few years - were probably back to where [they] were in say, 1992."

According to Roger A. Imperial, vice chairman of Acordia - the fifth largest brokerage in America and a subsidiary of Wells Fargo, "What mainly affected the rate increases were underwriting results. The rates being charged were inadequate - and for nine and a half years [prior to the first quarter of 2001], brokers and companies were reducing rates 10, 20 percent a year just to maintain their business and remain competitive. The stock market wasn't performing, so rates went up. Then 9/11 comes around, and bang - you're in trouble. It was the single largest loss known to the insurance industry."

Which, in essence, means that the prices are simply catching up with the times. As the economic landscape started sloping downward prior to 9/11, a good deal of the surplus from insurers' investments dwindled or evaporated entirely. That, combined with new government restrictions on how insurance corporations can invest policyholders' money, has also contributed to new, higher premiums. Says Fenniman, "Now you have some regulatory issues on where you can invest [that have] caused a major strain on the industry in terms of directors and officers and personal liability issues for all the professionals involved."

As far as directors and officers coverage is concerned, the interesting exemption from increasing premiums is D&O coverage. According to Imperial, "D&O didn't increase - it's the one stable factor in the marketplace without significant increase. It's readily available to people without a lot of losses."

Available as it may be, says Fenniman, "A big thing to remember is that [a board's] D&O policy won't respond if they haven't bought the proper insurance. Say the proper replacement cost of your building is $20 million, and you only buy $15 million [of coverage]; you have a total loss, the shareholders sue you, and your directors and officers policy will not respond - you'll have to pay that $5 million difference out-of-pocket."

What You Have is Worth More

Another reason why it's costing more to insure property in the city is that property in the city is simply worth more. While the tragedy of September 11th threw the New York real estate market for a brief loop in terms of property values, asking prices, and rents, it rebounded quickly, and today, nearly two years after the WTC incident, buildings and apartment units have increased in value as they would have had there been no attack. According to Fenniman, "Building values [are] going up. What it would cost to replace the building is all a function of dollars-per-square-foot. In the 1990's, that probably went from $75 per square foot to $125 per square foot to insure your standard, fire-resistant residential building in New York City. [Now], you go into high-rise and above-standard amenities buildings, and you can get into $150 to $250 per square foot."

Also, insurance industry pros caution disgruntled policyholders that while prices have indeed gone up, insurance accounts for a relatively small proportion of a building's operating costs - usually around just 10 percent or less. "There are buildings now paying $15,000 for a $100 million umbrella," says Fenniman. "Now, that umbrella might have cost $7,000 before, but it was so artificially low-priced, it's still a small proportion of the overall package price."

Like A Hot Potato

For some buildings, it's not a question of paying higher premiums - they've found themselves unexpectedly dumped from their insurance policies, and many are unsure why. In a word: Reinsurance.

Much as policyholders contribute a certain amount of money in order to be adequately covered in case of loss, so insurers spread the risk each carries onto the backs of others. In a building valued at and covered for $50 million, for example, the typical carrier might cover the first $5 million in case of catastrophic loss - a larger carrier might be good for $10 million - but beyond that, the balance is shouldered by a number of other carriers who assume a certain percentage of the building's coverage risk. This policy of reinsurance prevents the primary insurer from being bankrupted over a single claim of catastrophic loss.

According to Fenniman, this wouldn't be a problem, except that, "After 9/11, with the uncertainty of future attacks, you had major carriers withdrawing coverage because they didn't have reinsurance, since all the reinsurance contracts ran off by December 31st [2001]. Without reinsurance, a primary insurer is exposing their whole balance sheet to the full value of that building in the case of catastrophic loss. Now all of a sudden with reinsurance gone, you had underwriters very concerned over the concentration of value, and probably the worst availability for high-rise buildings in New York in 35 years."

"The entire insurance spectrum was affected - not just real estate," says Imperial. "There was plenty of reinsurance out there for very high values and very low rates, but after 9/11, all the reinsurers were hurt very badly - roughly 20 reinsurers paid huge amounts of losses along with primary insurance companies. At that point, everyone stopped writing real estate [policies] unless they could exclude terrorism, because they thought it might reoccur. Fortunately, on November 26th of last year, President Bush enacted the Terrorism Risk Insurance Act (TRIA), which stated that anyone who writes any insurance must provide coverage for terrorism. Insurance companies are being reimbursed based on the amount of business they write for claims of terrorism." That act has helped stop the hemorrhaging in the reinsurance market and stabilized prices somewhat.

What Your Building Needs—and How To Get It

Of course, not every single residential building in New York City is suffering under the same insurance premium pressure; so-called "trophy buildings," buildings valued at more than $50 million - as well as buildings located next to high-profile, potential targets - are the ones being most severely impacted by rising costs.

That said, however, even more modest buildings far from high profile cultural or business destinations are having their problems; according to Fenniman, "We have some carriers whose reinsurers are requiring that the buildings have sprinklers in them. Right now, we have problems with the underwriters' requirements being significantly above the building code standard. Some carriers just aren't getting involved because they can't get reinsurance because of this sprinkler thing. They end up staying in the commercial market."

So what's the best way of coping with an insurance bill that's threatening to break the bank, or an insurer who's turned in their residential policy chips and gone to greener pastures? First of all, don't fret too much; the situation now is better than it was a year ago, and by most accounts, it's getting better all the time.

"Every month that there isn't an act of terrorism in the U.S., there's a little step forward in confidence in the insurance market," says Fenniman. "Between that and the fact that insurers are learning how to price their terrorism coverage - it's very difficult to price a product when you don't have any actuarial experience."

So what do you do if your insurer cancels your policy? According to Imperial, "You shop. You shop and do the best you can, and frankly, you can get what you need at a higher premium now. There's plenty of market now. Shopping is good - the competition is almost good for the soul. Instead of having a $1,000 deductible, you could opt for just serious loss coverage and go with a $10,000 or even $20,000 deductible and save yourself 10, 20, maybe 30 percent. Maybe you're paying for a $200 million dollar umbrella that's superfluous if you really only need $25 million - you can reduce your cost that way, too."

To decide if your building is adequately - or even inordinately - insured, it's wise to get an appraisal from a professional, says Imperial. "Current, legitimate appraisal is what you should use. Insurance companies will help you if you don't know what the value is. An appraisal - a broker can help too - is a significant step."

Another Option or Two

The old truism about strength in numbers also applies to buying insurance. There are four or five "˜risk-purchasing groups' in New York State wherein people band together, pool funds, and get their own coverage. The programs range in coverage caps from $25 million to $200 million, and according to Imperial, they're relatively inexpensive for the amount of coverage you get.

"That's what a lot of individual people in New York are doing," says Imperial. "You may not be able to buy your own individual policy, but you can purchase coverage through a risk-purchasing group. All the groups I'm aware of are legitimate, and there's no problem with any of them."

Another way to shave a few bucks off the bill is to consider the following strategy: reduce your premiums in favor of a higher deductible, which in turn makes it easier to resist the temptation to file a claim for every spastic boiler or leaky toilet. According to Fenniman, "All those small claims - $5,000 in a smaller building, maybe $10,000 in a larger building - those are maintenance anyway. They should be lumped in with your maintenance budget, not your insurance budget. You don't need an insurance adjuster to come around every time you've got an overflowed toilet."

Some Parting Words

If you're fortunate enough to live in a pristine building valued at below $50 million, with good management, no outstanding engineering recommendations, and no claims history of great consequence, you're probably sitting pretty well as far as premiums are concerned.

But beyond the costs, the forecasts, and the consternation, there is in fact a glimmer of light on the murky insurance premium landscape. "Yes, the market is getting better," says Fenniman. "Is it going to be back to where it was? I doubt it - it was exceptionally soft - but if you talk to any of the prominent brokers in the city, and if you stay within the circle of expertise, most likely, you'll have the proper analysis done, and a manageable package. The firms have really fine-tuned it to make sure the buildings have the proper coverage."

Imperial concurs, adding, "The good news is that just over the last nine weeks, there's been a tremendous amount of competition in the business. Excess and high limits are readily available, the cost of terrorism coverage is in a lot of cases not very significant, and I've seen a lot of policies renewed without increase - which is a good sign. I've even seen accounts that have had their premiums come down. When that happens on the property side, at some point you can expect it to do the same on the liability side. If there was another catastrophe, all bets would be off - everything is subject to change - but that's the good news."

Hannah Fons is Associate Editor of The Cooperator.

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