At the recent Construction Lenders Risk Management (CLRM) Forum, one common concern among the nearly 200 industry professionals present was the growing impact of skyrocketing insurance costs on transactions. Increasing frequency and severity of climate events such as storms and wildfires have triggered steep increases in property insurance premiums. For many, insurance costs are as significant as interest rates when determining whether a deal is viable. While this is an industry-wide challenge, there are some strategies for lowering costs. Two strategies discussed at the CLRM Forum involved tailoring insurance coverage to suit risk tolerance and evaluating actual property conditions in order to provide detailed, focused data to insurance underwriters.
Construction Lending & Builders' Risk Insurance
In the interest of reducing costs, today's construction borrowers often want to reduce the term of their builders' risk policy to cover only the vertical construction phase. Builders' risk policies may not cover subsurface assets anyway, and there may be less risk exposure during excavation, grading, and site prep. In determining when to require builders' risk coverage, lenders should consider their own risk tolerance related to the construction schedule and the borrower. Other considerations include: At what point are valuable materials delivered to the site? Are they stored onsite before vertical construction begins? If so, identify an exposure threshold and require coverage when the threshold is reached. If a lender is familiar with the borrower and confident in their site management and contractor selection, they may feel more comfortable with a shorter term of coverage.
Commercial Mortgages & Property Coverage
As with builders' risk insurance, commercial property insurance can be tailored to suit risk tolerance. This can take the form of higher deductibles or coverage limitations. For cost savings without losing coverage, insurance experts at the CLRM Forum emphasized the value of providing rich, detailed property data in the underwriting phase.
Insurance premiums are based on the insurer's estimation of their risk exposure. As such, providing data that shows lower exposure is an effective strategy to reduce premiums. For example, Probable Maximum Loss (PML) modeling reports can be used to estimate risk from seismic or severe weather events. Providing PML data during underwriting allows the insurer to quantify their exposure and price accordingly.
COPE and Secondary Data
Perhaps most critical to the underwriting process is what insurers refer to as "COPE" and Secondary Modifier Data. COPE stands for "Construction, Occupancy, Protection and Exposure" and can be explained as follows:
- Construction refers to the materials and methods used in building construction. Different construction types have varying levels of susceptibility to damage from perils such as fire, wind, and water.
- Occupancy describes the purpose for which a building is used. For example, residential, commercial, industrial, or vacant properties pose different risks.
- Protection refers to the measures in place to protect the property from loss or damage. This includes fire protection systems, security systems, and other safeguards.
- Exposure Involves the external factors that may increase or decrease risk, such as the property's location, surrounding environment, and proximity to hazards.
Secondary modifier data pertains to additional factors that affect risk, such as proximity to a fire hydrant, the claims history of the building, or the age of the building.
COPE data can be gathered in conjunction with a Property Condition Assessment (PCA) while assessors are already collecting data regarding the construction and modifications to a property.
Property Resilience Assessments
Another tool in reducing insurance costs is the Property Resilience Assessment (PRA). As commercial real estate investors become increasingly sensitive to climate risk exposure, the PRA is gaining ground as a standard part of acquisition due diligence. A PRA analyzes how resilient a property is to the impact of climate-related hazards by combining regional climate data with asset-specific data. The report also includes recommendations for improving property resilience, which, when implemented, may improve COPE data.
There is a certain amount of subjectivity in insurance underwriting, especially for commercial portfolios. A PRA may offer additional value beyond COPE data by providing a richer picture of the anticipated performance of the subject property during an extreme weather event. It can help demonstrate responsible risk management practices on the part of the insured. Also, if an insurer is constrained by limited underwriting capacity, a property with a PRA may make the cut over a similar property without one.
Construction Lenders Risk Management Roundtable
Because insurance was a pressing concern for attendees, multiple sessions at the 2024 CLRM Roundtable Forum included discussions around the topic. Lenders engaged with insurance experts regarding nuanced coverage scenarios and best practices for underwriting. A common theme was clear communication regarding risk tolerance, property details, and coverage limits, along with the criticality of accurate and thorough property data.
To learn more about CLRM, visit https://www.construction-lender-risk-management.org.
For a deeper dive into resilience as a strategy for managing insurance challenges, Partner Energy is hosting a free webinar entitled "Property Resilience, Risk Mitigation, and Insurability" on July 18, 2024. Register here.
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Robert L. Knight, AIA
Robert Knight, AIA is an architect and consultant who helps clients refine and achieve their vision by connecting innovative ideas, exceptional talents, and progressive vision grounded in professional solutions. With 30+ years of experience, Bob’s specialties include due diligence consulting for real estate investors, financiers, attorneys and other stakeholders, as well as comprehensive master planning, energy and water efficiency, and return on investment analysis.
