Why CRE Insurance Prices Are Becoming More Volatile

Commercial insurance prices are rising as increased costs from climate change, the supply chain crisis and inflation take hold, Westchester, a commercial property, and casualty insurance underwriter, said in a new report.

Climate change is adding to the expenses insurers need to recoup and plan for, said the authors, as related natural disasters produce more frequent and severe insured water, rainfall, and flood losses.

Also, the supply chain crisis is making repairs to commercial properties more expensive with higher costs for construction materials like lumber, steel, and gypsum.

Another factor is inflation, which is driving up costs as well.

These factors are now colliding with the long-standing trend of undervaluing the true cost of asset replacement for property insurance purposes, the authors said.

Accurately and comprehensively valuing the replacement cost of a commercial structure for insurance purposes, is a difficult process that is critical to ensuring that insureds are paid accurately and quickly in the event of losses, they pointed out.

“More accurate valuations would generate improved modeling, enhanced risk management of assets and business continuity, and more precise pricing of property risks, among other benefits,” the Westchester authors urged.

The Impact of Climate Change

Expanding on the impact of climate change on commercial property insurance rates, they noted that from January through September 2021, rising global temperatures appeared to have contributed to 18 weather related disasters with losses exceeding $1 billion each in the US, a record high.

“The greater frequency of severe catastrophic events over the past 5 years have redefined this ‘new normal’ on an almost annual basis,” the authors asserted.

Judging the risks on existing catastrophe models, they warned, may create a false sense of security.

Costs Are More Volatile 

The supply chain crisis, the Westchester experts cautioned, has made the costs to rebuild damaged or destroyed buildings more volatile.

The massive upsurge in strong end-market demand caused by the pandemic made it impossible for suppliers, container ships, railcars, and trucks to serve everyone’s needs simultaneously, causing shipment delays and transportation disruptions, the report said.

The authors are predicting the tight availability of commodities and building materials will contribute to further price increases well into 2022.

Asset Replacement Costs

Rising material and labor charges with the current inflation strongly suggests that asset replacement costs are presently undervalued in property underwriting models, the authors cautioned.

“Inadequate consideration of asset replacement costs has an adverse effect on insurer modeling, pricing, business continuity plans, and the duration of claims adjustment and payment,” they said.

The costs for the insured of rebuilding or replacing a building with materials of like kind and quality and the building’s contents including furniture, fixtures, machinery and inventory, require more diligent valuations and proper reporting by insureds and brokers during the underwriting process to ensure there is sufficient coverage in the event of an insurance claim, the authors advised.

AI Won’t Help

While artificial intelligence and machine learning technologies have improved the estimations of property insurance losses from natural disasters, the report said the models’ forward-looking projections strain to account for the increased frequency in nonconforming weather events, seesawing damage repair costs, and longer-duration business interruptions caused by both wide scale and prolonged power outages.

Without accurate projections of potential losses, the Westchester authors cautioned, senior management at commercial property building principals may fail to set aside enough capital to cover the organization’s retained risks or may procure property insurance with insufficient coverage limits.

To better understand the changing risks, the report said each party needs to examine in depth and detail how they can in their respective roles develop more accurate and near-real-time data on building condition, local drainage systems, real estate, and housing development trends, access to available construction materials and local construction personnel, and other loss exposure information.

“In light of a future with more frequent and severe catastrophic weather events and related insured losses, the property insurance industry should consider providing policyholders greater support for taking certain risk mitigation measures. That support may include potential

premium discounts or credits for protective measures such as improving the insulation of buildings and pipes, retrofitting storm drainage systems, and installing electrical generators for unexpected electrical outages,” the report concludes.