Real Estate Insurance Premiums- A forecast for 2023.
I doubt readers would be surprised to know that Inflation is impacting the cost of just about everything. The rate of inflation in the past two years, and especially the last 12 months has been especially alarming. Insurance premiums are not exempt. But lets look at some less obvious trends that I expect to have a compounding affect on the cost of insurance, and especially the cost of insuring real property.
Insurance companies, like banks, make most of their profit from return on investment income. That is; income earned by investing their policyholder premiums, also known as carrier ‘reserves’. Historically, insurance companies in ‘risk-on’ economic environments have been able to invest their policyholder premiums in relatively risky endeavors. AIG had to be bailed out to the tune of $180 billion dollars for their risky financial strategies. Some will say regulators were to blame for deregulating the use of credit default swaps, while others will say that it was a blatant failure in AIG’s risk management practices to sell credit default swaps without collateral or hedging its exposure. I tend to agree with the latter camp.
The above liquidity crisis has resulted in increased financial scrutiny and limitations on how carriers can deploy their reserves for investment returns. Despite a ‘risk-off’ financial environment bolstering short-term bond yields as of late, the returns are nowhere near capable of offsetting the impact of inflation and the increased cost of construction in the near term.
OK so we’ve discussed the inflationary and interest rate impacts on insurance costs. Lets look at the third variable impacting the bottom line of insurance premiums. The increase in the cost of construction. First lets point out that an insurance policy is a contract of indemnity. That is, in exchange for a price (the premium) agreed upon today, a carrier agrees to indemnify (make whole) the insured in the event of a loss at some point in the future. So what happens when the cost of indemnifying something suddenly increases dramatically? Not as a result of inflation or interest rates, but as a result of relatively sudden supply/demand imbalances and shortage’s in construction materials? Well, we have what is otherwise called an increase in the cost of construction (ICC). In the past two years, the Construction Cost Index, representing ICC has risen over 60% nationally*. Insurance carriers have not been able to keep up with the impacts of the increase in the cost of construction, only compounded by the recent rise in inflation. Why not?
The answer is both simple and complicated. There are a myriad of reasons, some of which would require their own article to explain and most of which are too complicated for the average reader to digest. State regulation, rate filing limitations, imperfect actuary modeling, increased competition and the nature of hard & soft markets are but a few painful realities that insurance carriers must constantly navigate. I will address these further in future articles.
There is however no disagreement that we have entered a hard market, and that the market isn’t getting softer anytime soon. As for my argument suggesting that carriers have not yet caught up with (and properly accounted for) the increased cost of construction, there is plenty of data to support this. But you only have to look as far as the industry combined ratio’s in 2021 and 2022. It becomes especially concerning for the consumer when you compare the combined ratio’s by the industry increases in premium.
Despite premium growth of 17.4% in 2021, the industry combined ratio for 2021 was 106.2%. What does this mean? In simple terms this means that despite paying 17.4% more premium in 2021, the insurance company still had an underwriting loss of 6.2%. For the insurance people reading this, I know I did not account for GDP growth on premium. Subtracting a 5.7% growth in GDP from the 17.4% premium growth and we’re still talking 11.7% increases in premium.
But maybe 2021 was an anomaly? And certainly one would expect that after a ‘band-aid ripping’ increase of 17.4%, the market for 2022 would see some normalizing affects?
Well, lets take a look. The forecasted 2022 growth in premium, as of November 2022 is a whopping 14.5%. Which after adjusting for an anemic 1.9% rate of GDP is an even bigger increase than 2021.
But Allen, this has to be it right?! Two years of double digit premium increases and carriers have to be nearing underwriting profit?! The forecasted combined ratio as of November 2022 is 107.6%, representing an even bigger loss in 2022 despite an even bigger increase in premiums…
It goes without saying that I anticipate an even worse year for policy holders in 2023. Many insurance measurements are lagging indicators. Carriers are just now re-underwriting with a focus on increasing the building ‘limits of insurance’ to construction costs more commensurate with today’s environment. While this doesn’t necessarily affect rate, it does affect the underlying rating ‘basis’. This is yet another factor that will increase premiums YoY.
My 2023 forecasted YoY changes:
Base Rate change for Multi-family Real Estate (Condo’s/Apartments): 5%
Adjustment to RC building valuations: 8%
Inflation adjustment: 3% (3% growth from 2022)
Gross YoY Premium growth (net GDP affects): 16%.
I suspect loss reserves for open claims and incurred but not reported (IBNR) losses haven’t been fully adjusted for increased cost. This might not impact 2023 premiums but it will continue to weigh on combined ratio’s for the next 2–3 years. The above forecast is national average. Carriers will be looking to increase building valuations and rates for all of 2023. They will also tighten up on their underwriting guidelines and loss control their books with heightened scrutiny. This is the year to be proactive and get out in front of your renewals.
What can you do as a consumer? A couple things.
- Find an agent/broker that can assist you with developing proactive risk management strategies. Few can provide these services in a meaningful way. General agencies cannot hope to provide the below services to the myriad of industries they claim to serve. You need a specialist in your industry. But as carriers underwrite with increasing scrutiny, having the following minimum best practices in place will help your operation stand out from the crowd and command the most favorable rates; Loss Control plans to identify hazards and perils that could contribute to the severity or likelihood of losses occurring. Disaster Recovery plans in place to reduce the cost of losses when they do occur. Risk Management plans will help measure and define the success of your efforts over time. Having a risk finance strategy will also help determine your capacity and ability to self insure some level of risk. In a hard market, it will make increasing sense to self-insure more risk, because you will pay a premium to transfer the first layers of risk to a third party.
- SHOP! The time and effort you will spend to seek out alternative quotes will never be more valuable than it is now. Carriers in the beginning of a hard market, especially one with an uncertain duration and depth, will have very different approaches in their ‘renewal’ and ‘new business’ underwriting strategies. The same risk paying $100,000 and receiving a 10% increase from their renewal underwriter would likely receive a 10% discount from the same company’s new business underwriter if they were currently insured by another carrier. And 15% increases compounding YoY over 3 years….well, that is simple enough math.
- Consider alternative deductibles and self insure what you (safely/reasonably) can.
- Think twice before filing smaller 1st party property claims. Speak with your insurance advisor before filing a claim.
- Repair and/or replacement worn or aging building components/utilities or at least develop a plan to do so in the near future. Having a ready plan to replace aging infrastructure could be critical in convincing an underwriter that they won’t have to worry about you filing an impending claim.
- Definitely do NOT listen to that roofing contractor canvasing your neighborhood, telling everyone they can get you that new roof for ‘free’, unless of course there actually is some catastrophic hail or windstorm to account for the damage. They might be able to argue its an insured loss, but you will pay for that ‘free’ roof in spades.
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