Many large carriers have recently expressed concern regarding underinsured commercial properties. In a recent interview with Business Insurance1, Michele Sansone, President of North America property business at Axa XL, stated, “We’ve seen numerous instances where we’ve gotten claims and the values are a lot higher than what was submitted as part of the schedule. That’s really disturbing because we set lines on those, we base our engineering surveys on those, and we are obviously charging based on those.” . Aside from the prevalence of after the fact observation, there are also several market indicators factoring into the increased focus by carriers and reinsurers to more granularly understand the underlying risks associated with insuring commercial properties. This would include things like:
- Number of catastrophic total losses increasing in frequency and severity
- The transition into a hard market, both on the commercial and reinsurance front
- Losses of investment income returns due to volatile financial markets and low interest rates
- Increased customer expectations and reputation risk due to social media
- Premium leakage due to insufficient coverage or inaccurate occupancy classifications
- Entry of Insuretech competition into the marketplace
- Reinsurers are expected to increase scrutiny on a carrier’s underlying risks
A Commercial Underinsurance Case Study
A portfolio analysis for a large carrier encountered an example of multiple buildings in a large multi-family development. The coverage limit was determined by calculating the details of only one of the buildings, without any visualization of the property, and assumed all buildings were identical and typical box-shaped buildings. In fact, each building had an atrium and therefore double the amount of exterior wall materials. This analysis highlights the need for accurate construction information about any particular risk where information is sometimes challenging to obtain. Additionally, the presence of attached structures was not considered in the reconstruction cost estimate. Lastly, the survey of the properties ordered by the carrier returned a much lower estimate of reconstruction cost because the survey approach is focused primarily on risk exposures rather than providing a detailed analysis on reconstruction costs. Ultimately, this complex was approximately 43% underinsured.
Other contributing factors to commercial property underinsurance include:
- Lack of information on a property being insured at time of binding the coverage (owner lack of knowledge, assumptions made by the broker/owner, incomplete applications)
- Incorrect or missing information used for reconstruction cost estimate (e.g. square footage, construction type, roof materials, sprinklers, elevators, plumbing fixtures)
- Lack of regular portfolio review to verify coverage limit is keeping up with actual cost over time (using only inflation guard to increase coverage limits versus performing intermittent portfolio reviews)
- Changes in ordinance or law, costs of permits
- Proper occupancy classification which can change over time and helps determine appropriate machinery/equipment valuation
- Coverage provided sight-unseen without verification on smaller properties due to cost-value benefit
- Post CAT event demand surge of building material costs and labor shortages can increase the cost of reconstruction after a major event such as the CA Camp Fire
What Carriers Can Do to Protect Themselves and Property Owners
It’s no longer enough to rely on large co-insurance and margin clause requirements, as this leads to a sacrifice in customer experience at time of loss; which is what some carriers experienced after the 2017/2018 CA wildfires. Nor is it recommended to rely solely on inflation guards or cost indexes when accounting for changing reconstruction costs over time as fluctuations vary greatly not only by state but also by locality.
It is recommended to use a commercial property reconstruction valuation model that tracks reconstruction costs on a micro-geographical level where costs are evaluated locally and are specific to the location. A comprehensive commercial prefill can also help take the guesswork out of determining a property’s attributes. Commercial occupancy is another variable that is important to pay attention to. For example, a trend in commercial real estate is leasing retail space under large multi-unit apartments or condos. These occupancies change over time as does the exposure. The risk of insuring retail space for a real estate office would be far less than a bakery, for example, which has more expensive and hazardous equipment. Being aware of the additional risks posed by changing or unknown occupancies is critical to ensuring proper coverage is provided for the actual exposure.
However, ensuring a risk is properly valued does not stop at the point of policy issuance. Intermittent portfolio reviews to ensure property coverage limits are keeping pace with construction material and labor at local market levels is essential in protecting commercial property owners should disaster strike.
Learn more about the CoreLogic Commercial Express platform for commercial risk assessment and valuations here.