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March 2002
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ISSUE 4
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Volume 1
Issue 4
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Community Associations Grappling with Rising Insurance Costs
When the board members of Nordic Inn began shopping for insurance in October, they anticipated some difficulty in obtaining coverage for the Lincoln, New Hampshire condominium. A fire (work of an arsonist) had resulted in a $4 million loss the prior year, and with the insurance industry still reeling from the effects of the September 11 terrorist attacks, “we knew things would be a little strange,” Dick Edry, a Nordic board member and an investor-owner of several other condominium units, recalls.
But they didn’t know just how strange. Sixteen insurance agents later and just past the expiration date for their existing coverage, Nordic finally negotiated a renewal policy, and saw their annual insurance premium jump from $30,000 with a $1,000 deductible to $120,000 with a $10,000 deductible.
That was a bargain compared with estimates ranging from $175,000 to $225,000,” Edry says, “Very few companies were willing to take a $12.5 million property. No one wanted that kind of risk, especially with the fire loss. We didn’t cause the fire,” he added. (The arsonist responsible was caught and convicted.) “But we still got beaten up pretty well.”
A Different Market
Nordic Inn’s experience was extreme, and certainly complicated by its recent claims experience. But most community associations shopping for insurance during this renewal season have found the market much changed from the one they had seen throughout most of the past decade.
September 11 is responsible for some of those changes. Property and casualty losses from the terrorist attacks are expected to total anywhere from $35 to $80 billion, making this (even at the lowest end of that range) the single largest insurance loss ever for a manmade catastrophe. To say that insurers have become somewhat more risk averse is a bit like saying the Enron debacle has made accountants a little sensitive about off-balance sheet assets.
Before 9-11, Nordic Inn probably would have found insurance without much difficulty, even with its arson claim. That was because primary insurance companies regularly laid off a portion of their risks in the reinsurance market. But the reinsurers, which, in effect, provide insurance for the insurance companies, took a huge hit from the September 11 claims. As a result, their appetite for secondary risks has diminished dramatically, leaving primary insurers to assume most of the risks they underwrite on their own.
From Soft to Hard
That is one reason Nordic’s board found the market so inhospitable to their request for $12.5 million in coverage. But 9-11 was not the only dynamic at work. Several months before the planes slammed into the World Trade Center and the Pentagon, a slowing economy and cyclical trends had already begun to transform a “soft” insurance market, characterized by intense competition, abundant coverage, and favorable rates, into a “hard” one, defined by fewer competitors, less expansive coverage, and rising premium costs.
The shift was “long overdue,” according to Jeff Grosser, vice president of Rodman Insurance in Needham. The insurance cycle typically moves from soft to hard every four or five years, he explains, but because of the sustained economic boom, “we missed an entire hard market cycle.”
The point that Grosser and other insurance experts emphasize is that the fallout from September 11 simply highlighted a market transition that was already well under way-a transition that was fueled at least in part by the stock market decline.
The insurance industry’s underwriting losses have been well publicized, but its investment losses are equally significant. Through the third quarter of this year, insurers reported a 5.7 percent reduction in net investment income and a 45.7 percent drop in capital gains. Those statistics are important, Barnard Gitlin, president of The Global Insurance Network, explains, because a booming stock market allowed insurance companies to do “cash flow underwriting,” – using premiums primarily as a source of investment capital, and relying on investment income to generate profits. As their investment income has declined, insurers have been forced to rely more on premium revenue, which means they have begun to focus much more on the relationship between premium rates and covered risks. September 11 and the shriveling of the reinsurance market have had a “multiplier effect” on those economic trends, Gitlin says.
A Tough Message
Press coverage of the economic tidal waves flowing from September 11, has made our job a little easier,” Grosser suggests, by highlighting public awareness of the insurance impact, and making condominium trustees and community association managers somewhat less inclined to shoot the messengers when it comes time to renew expiring insurance policies. But the message Grosser, Gitlin, and their colleagues have had to deliver has not been a pleasant one.
Premiums have increased virtually across-the-board for community associations, although not as much as some alarmist press stories had predicted. “I haven’t heard of any condominium that has not been able to obtain insurance,” Barbara Kansky, a professional director, says. Still, the increases have been significant, averaging 20 percent to 30 percent for communities with a good claims experience, but going much higher 50 percent or more for those with a less favorable risk profile. At Bishops Forest, a 269-unit suburban town-house development that Kansky manages, the premium increased by only 14 percent, which “wasn’t bad,” she says, all things considered.
The lack of terrorism insurance has been much in the news as reinsurance companies have refused to offer that coverage and primary insurers have begun to exclude it. But that has not been an issue for condominiums, primarily because “they’re not typically reviewed as major terrorist targets,” Wesley Blair, vice president of Brookline Savings Bank and Treasurer of CAI-New England, observes. “A large, high-rise, high visibility condominium might be affected, but we’ve approved loans for those types of associates since the attack, and terrorism insurance was not an issue.
Insurers may not view terrorist attacks as a serious risk for community associations, but they are scrutinizing other risk factors much more intently than in the recent past. While associations can’t do anything about the “hard market” cycle or the fallout from September 11, they can do a lot about their risk profile and their claims experience. Associations that address these areas effectively can improve the odds that their premium increases will fall into the 20 percent to 30 percent range rather than the 50 percent and higher category.
Start With the Deductible
Industry experts suggest a variety of strategies to help control condominium premium costs. But virtually every list of “what associations should do” begins with this advice: Increase your master policy deductible. The $1,000 deductible that has been something of an industry norm should be closer to
$5,000 and for some risks (such as ice dams) that are likely to produce repeated claims, Associations should make the deductible per unit rather than per-event. Using that approach, on a claim involving multiple units, each unit would have to pay the specified deductible before a master claim would be triggered. As a result, many relatively small claims would never be charged against the master policy.
That is appropriate, according to Gitlin, who says associations should make their master policy do what it is intended to do- “cover catastrophic losses. Owners should not expect to collect every dime of their loss from the master policy.”
Owners can increase their coverage to dovetail with the higher master policy deductible at relatively low cost. Most unit owner policies already have $2,000 of coverage for the master deductible, Gitlin points out; increasing that to $5,000 would increase the owner’s annual premium by only about $50. And the penalty unit owners will pay (if any) for prior claims is far smaller than the penalty the community associations will incur for multiple “nuisance claims” against the master policy.
Affirmative Actions
Insurance industry executives and condominium managers suggest a number of other steps community associations can take to control their premium costs, including the following:
Be proactive about risk management. With fewer carriers in the market and less competition, companies can afford to be more selective and more demanding. As a result, they will look far more critically at loss experience and building management. Knowing this, Rodman’s Grosser advises associations to “make the kinds of capital improvements that will make you viable in the marketplace.” “Preventing claims is as important as properly managing them,” agrees Kansky, who emphasizes the need for associations to pay attention and respond quickly when their insurers suggest risk mitigation measures. Eliminate unnecessary coverage. Terrorism coverage is one feature that community associations could eliminate easily) to the extent that it is still available), Gitlin suggests. He also puts pollution coverage on that expendable list. And he thinks most associations could comfortably reduce their umbrella coverage well below the $50 million to $100 million that many carry. “There has never been a claim of that size in the history of community associations” he points out. For most associations, he suggests, “$5 million is more than adequate.”
Anticipate insurance cost increases and budget for them. Borrowing to cover the increased cost won’t be an option, according to Blair, who says most banks (including Brookline Savings) will view this as an operating expense. “Associations need to tighten their belts or increase their common area fees to cover it.”
Encourage unit owners to add “loss assessment coverage” for “off-the-wall” losses no one could anticipate, Kansky suggests. She cites an undetected underground stream and “sink-holes” as two examples that could result in uninsured claims requiring huge unit owner assessments.
Take a “big picture” approach to insurance coverage and to relationships with insurance carriers. “Jumping from carrier to carrier to save a few dollars,” common in a soft market, is not the best strategy in the current environment, Grosser says. “Loyalty does count,” he insists. “Insurance companies are more inclined to stay with a risk they have had for years.”
Educate unit owners. This probably ranks near the top of the priorities cited by industry experts. Common sense suggestions, such as increasing the unit owner’s deductible obligation, are likely to induce knee-jerk opposition, which management companies and trustees must combat. “Many owners think the master policy cost is someone else’s problem,” Kansky says. “They need to understand that the association’s insurance is their problem. And if the association can’t get insurance, it’s going to be a very serious problem for all of them.
[PRINTER FRIENDLY VERSION]
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Orten & Hindman, P.C.
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