How Property Insurance Risks Can Impact Real Estate Valuation
- Published
- Jan 29, 2025
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EisnerAmper and Risk Strategies discuss property insurance risks and its impact on real estate valuation.
Transcript
Amy Menist:Thank you Bella. Hello and welcome to today's webinar, how Property Insurance Risks Can Impact Real Estate Valuation. My name is Amy Menist. I'm an audit manager with EisnerAmper's Real Estate Services Group. As the world faces increased risks from intensifying frequency and severity of extreme weather related events, the impact on the real estate industry is becoming clearer in terms of cost and availability of insurance, business interruption and real estate valuation. So today I'm pleased to be joined by our panel of industry experts including Steve Edelstein, the insurance broker and vice President of Risk Strategies, Michael Marinelli, team leader of the National Risk Analytics Practice at Risk Strategies. Neil Axler, managing director of EisnerAmper's National Real Estate Valuation Practice, and Robert Meulmeester, the director of EisnerAmper's National Real Estate Valuation Practice. So to kick things off, I'd like to ask each of our panelists to give a brief introduction of themselves. So let's start with you Steve. Can you please share with everyone a little bit about yourself and your role with risk strategies?
Steven Edelstein:Sure. Thank you for having me. I am the Vice president of Risk Strategies with a focus on commercial real estate.
Amy Menist:Okay, thank you Steve. And now over to you Michael.
Michael Marinelli:Thank you very much, Amy. My name is Michael Marelli. I head up our national risk analytics practice here at Risk Strategies Company, really dealing with property and casualty risks related to large scale real estate portfolios and a whole host of other industries.
Amy Menist:Thank you Michael. And now for you Neil.
Neil Axler:Hi everybody, I'm Neil Axler. I'm a managing director here at EisnerAmper. I lead our national real estate appraisal practice. We do appraisals throughout the United States, plus we do a lot of international work and I'm based here in New York City.
Amy Menist:Thank you Neil. And now last but not least onto you, Robert.
Robert Meulmeester:Hi everybody. My name is Robert Meulmeester. The reason for the funny name is because I'm from the Netherlands, so that makes it a little exotic and my focus is real estate appraisal work and real estate due diligence work here at Eisner. I work together with Neil and a few other folks here in the firm doing these type of valuations nationwide and internationally. Aside from that, I also do some teaching at Temple University. So thanks again. Great to be here.
Amy Menist:Great, thank you Robert. And now I'd like to start us off with the commercial insurance marketplace. So let's talk about the current state of the commercial insurance marketplace. So Steve and Michael, can you please explain for the viewers the current state of the insurance and how major market drivers such as climate related disasters, inflation and economic conditions as well as higher litigation costs could impact the insurance industry?
Michael Marinelli:Sure, thank you very much Amy. Well, I'm going to start off with property insurance right now. It is still a tough market, but there has been somewhat of an equilibrium reached at the end of quarter four in 2024. That is due to some things such as expanding capacity with reinsurers and primary insurers. That being said, we all see what's going on in California with those devastating wildfires. Many different catastrophe models are modeling out those losses to be roughly up to 35 billion in damages. Now we do believe that that will or could affect pricing in the future and right now a lot of different agencies including risk strategies, we still see that there has been some equilibrium reach in the property market that Outlook is getting more uncertain not only because of the natural catastrophe disaster in California, but it happens so early in the year.
This can lead to not immediate but moderate price increases throughout the year. But what's really going to happen is the insurers and reinsurers are going to start looking at the markets. There's going to be some tighter underwriting and some stricter policy language to try and mitigate the losses that they just experienced and are still experiencing with those wildfires burning. What we are seeing from a risk strategy standpoint, we do have our state of the market 2025 initial outlook. You can find that on our website. A good risk with limited natural catastrophe exposure and no losses is looking at a minus five to plus 5% increase on renewal, A tough risk. So that could be in a cat exposed zone, that could be a risk with a lot of losses. You're looking at most likely between a plus 15 and plus 25 and then some increase in 2025 just based off of market conditions.
Moving now over to casualty, there are a few different things that are really driving those increased pricing trends. One of those being economic inflation that is driving pricing as well as social inflation is another thing that is driving these increased prices. You're looking at concerns over reserve adequacy due to poor claim development. What that means is when the actuaries were pricing where they thought reserves would be ultimately claims are developing hotter and faster than they thought were going to happen and that is causing now these insurers to increase some costs to make up for the poor development in claims. You are also looking at a lackluster investment return from a lot of these large insurers. The market the last couple of years hasn't been great, so some of the returns that they're getting on their own dollars are not adequate enough to balance out the negative reserve development.
You're also looking at third party litigation funding and nuclear verdicts and thermonuclear verdicts. A nuclear verdict is a verdict, a jury award above $10 million and a thermonuclear verdict is upwards of $100 million plus. All of that together is leading to some pretty hard casualty market. We're seeing the market somewhat soft for cyber and d and o, but when we're looking at commercial auto and umbrella, you're looking at a hard market there. Umbrella is a plus five to plus 35% increase. Auto is plus five to plus 25%. Workers' compensation is flat to 5% increase. That is a current profitable line for almost all of the insurers and general liability is flat to plus 5% as well.
Amy Menist:Great. Well thank you Michael. So with that said, could you please then explain for our viewers the methodology and the types of data that insurance brokers and underwriters use to determine a profile risk?
Steven Edelstein:Sure, thank you. So when the insurance companies take a look at a particular property or building, they take into account what they call COPE information. So COPE information stands for construction, occupancy protection and exposure. This is really the crux of what a lot of the carriers base their pricing on and their coverage levels are. So it's really important that this information is accurate and up to date when possible. So the C in COPE stands for construction. So when you think of construction, think of construction type, so frame mac, you're not combustible concrete, things like that. So certain things that the insurance companies look for are is the builder using fire resistant materials, is the engineering design robust and can the property withstand the natural disasters that we're seeing and the future natural disasters. The O in COPE is occupancy, so that usually includes the type of business and the activities within the building. So when you're thinking occupancy, think of rentals versus owner occupied. Also think of the type of tenants, if it's retail or mixed use or industrial, usually that can be a little bit more risky than other types of tenants. So occupancy is a big part because the insurance companies want to really understand who you're putting into your buildings and what exposure those bring to the insurance companies themselves.
The P in COPE stands for protection, so fire prevention and security systems. So they're taking a look at how you're safeguarding your buildings, whether that's sprinklers, central station, alarm systems, type of electricity or electrical that you have in place and all the other things that you can utilize to protect your building from. Mostly this is mostly property risk. The last thing in COPE is the E or exposure. So think neighboring areas, think the actual location itself, so where is that property located and what risk does that bring along with it, along with also the neighboring your neighbors around your particular real estate building. So we want to you the poll question.
Amy Menist:Yes. So now on to our polling question, Bella.
Bella Brickle:Poll #2
Amy Menist:Thank you, Bella. Steve, out of curiosity, while we're talking about COPE data, is there a particular type of the data actually that real estate owners and operators tend to be more concerned with? Just out of curiosity off the top of your head, ballpark
Steven Edelstein:A particular part of it. I would say the electrical has been a big issue. Buildings built between 1960s and 1970s. We're finding a lot of federal Pacific breakers on those which the insurance companies don't particularly like because they trip or they don't trip rather. So life safety type of issues with buildings are more and more scrutinized every single day. So they want to make sure that the building owners have a plan in place to mitigate against that risk.
Amy Menist:Understandable. Great. So the answer was actually construction, occupancy protection and exposure. Great. So now that we understand the current state of the commercial insurance marketplace and the methodology and types of data that insurance brokers and underwriters use to assess profile risk, can you please describe the different types of risks affiliated with real estate and strategies that owners and operators can implement to decrease their risk profile?
Michael Marinelli:Thanks Amy. So improving the risk profile is something that risk strategies that we really aim to do. Really what you're supposed to do is tell the best story to the insurance marketplace that's going to yield you the best results when it comes to pricing and premiums and deductibles and specific layering. So some things that we do at risk strategies, we do have a loss control team. So they would come in, they would walk through the property, ensure that there's sprinklers and things of that nature, things that are going to, if there's a fire, how do we suppress that fire with a good fire suppression system? Things of that nature. From my seat heading up our analytics practice, we're going to do heavy risk mapping, we're going to do loss forecasting, analytical modeling, benchmarking. Where does your account or this particular real estate portfolio match up against similar size and scope and similar program structures to the benchmark and who we have within our system?
We are going to then take that information, we're going to work with Steve's team, our loss control team, our claims team, and we're going to work cohesively to ultimately lower your total cost of risk, ultimately see what improvements need to be made so when the insurer comes out and they walk through your property or your portfolio of properties that they're not finding any red flags and that the renewal or the new price that you're getting for your insurance is going to be in line with how the risk looks. And that's ultimately what we're trying to do, tell a good story to the insurance marketplace. We do use a heavy dose of analytical modeling. We do usually go up against the underwriters that we work with because I don't like to say we work against them. We do work with them to get our clients the best deals possible. And Amy, if you could just go to the next slide please. So Steve, I'm going to kick this over to you on improving the risk profile.
Steven Edelstein:Yes, thank you Mike. So certain ways to really improve the risk profile to go above and beyond just submitting the applications and loss runs and telling a good story to the insurance company is to utilize what we do is we utilize our loss control team to make certain recommendations. So that particular building, so what are sensors really popular or really commonly seen in more high-rise type of buildings where you could have a leak on the top floor and that could go all the way to the bottom and cause significant damage. So water sensors, which are usually on the less expensive side are a good way to show the insurance companies, Hey, I'm mitigating risk. And there's also a way for you to limit your claims and catch the claim early. Same thing with fire alarms, smoke alarms and security cameras. So all of these things make the particular carriers looking at a risk more and more comfortable.
So the more you can do that, the better. In addition to that, there are certain pre underwriting reports that we can share with the carriers that what you're doing in terms of capital improvements, let's say you're acquiring a building and there's a lot of work that needs to be done by letting the insurance carrier know that A, I'm doing x, y, Z capital improvements. It shows them again that you are taking into consideration what the insurance carriers are considering and mitigating the risk, which in turn, sorry, lowers the premium and gets you more leverage with that particular carrier.
Updating the CapEx items that we're talking about include updating the roofs, electrical heating, plumbing, things of that nature. And then also what we want to convey to the insurance carrier when you do have claims is how you're handling the claims. Do you have a particular checklist that your property managers are using to catch that claim early and report that incident early? And really are you closing out those claims in a timely manner as well? So Mike, I'll kick it over to you to discuss a little bit of what we do from the cat modeling perspective.
Michael Marinelli:Sure, thanks Steve. So we utilize a proprietary cat modeling system. There's a bunch of them out there, it's one of the larger ones. And ultimately what we're able to do is we can take your portfolio of properties and we can model out one in 100 year floods, quake wildfire for those of us up in the New England, New York region, what does a severe winter storm look like? And really what we can do is find what is your PML, what is your a l meaning, what's your probable maximum loss on property x, y, Z on all of your portfolios together? And that's really going to help us get you better terms. It's going to help us get you better coverage from a loss control analytics and claims perspective. We want to arm you as well as our internal teams and the underwriters all with the best information so we can ultimately get the best deal.
We use cap modeling every day. We were modeling a lot of our clients out in California where we think the wildfire could go, what is the PML for some of those properties there. The other thing that we're able to do is overlay some pretty severe storms. So we were able to identify what we basically took our property program, all the properties that we know and we were able to identify which of our clients were going to be hit by Hurricane Helene. And we can see based on that what we think the PML would've been for each of those properties and it's a really great tool to use when you have a really bad storm coming through. We also can do convective storm, so think about coming through Oklahoma or some of those tornado alley storms. We can take a look at that as well. And it's just ultimately arming ourselves, the carrier and yourselves with the best data possible so we can all make the best decisions on your risk.
Amy Menist:Great. Thank you Michael. This actually brings us to our next polling question, Bella.
Bella Brickle:Poll #3
Amy Menist:Michael, we did actually have a question come in for our q and a. Just on a quick high level, while we're waiting for the poll, could you actually explain what social inflation is?
Michael Marinelli:Sure. So social inflation is a term that's used and it really describes the social, legal and economic factors on why claims are increasing. So for example, you'll see litigation costs, right as these litigation costs continue to increase, and you could see I was just in Miami for a client meeting and every mile on the mile there's a, were you hit by a vehicle? Were you bitten by a dog? All those personal injury attorneys that is a piece of social inflation. On top of that jury awarding juries are pretty sympathetic to plaintiffs. So these defendants are, and these businesses and the insurance companies are looked at in a slightly skewed light, which is awarding juries are now awarding these plaintiffs with larger deals, larger payouts. So that's really the crux of social inflation, it's really just social attitudes and jury verdicts and just increased litigation costs.
Amy Menist:Thank you Michael. So the actual answer was risk equals hazard exposure and vulnerability. So now that we understand insurance, let's discuss real estate valuation. Neil and Robert, can you please explain for the viewers the different approaches used to determine an asset's fair value?
Robert Meulmeester:Thanks Amy. Yeah, sure. Oh thanks Amy. So yeah, the different approaches to value that we typically rely on are the market approach whereby we essentially compare properties in the market that were recently sold, properties that are ideally sort of near the subject but not necessarily. They may also be a markets that are overall similar in nature, similar in competitiveness. The other approach to value that we rely on a lot is the income approach to value where you have the direct cap, which is like a snapshot, snapshot of anticipated income for just your next year income as well as a DCF, which is the discount cashflow whereby we actually go further out in time and which is an approach is especially helpful when you're talking like a non stabilized property. So property that's going through a lease for instance, or a property that has a lot of lease rollover coming up.
And then finally the cost approach where you can either rely on the reproduction cost or the replacement cost new, which we'll be talking about in more detail in a little bit. Typically for these type of values, I think a lot of it is very much transaction driven and we oftentimes do this for estate tax matters, but also lending matters and other types of financing like sale and leasebacks. The cost approach when we do these fair market value type of valuations is not as typically relied on, maybe only when talking something like really unique, a unique property that simply doesn't sell as much as well as a property that simply doesn't generate income. Any other thoughts, Neil?
Neil Axler:Yeah, let me jump in on this, Robert, on the income approach that's most relied upon for income producing properties. And what's so important with this session today is the expenses, when the expenses are too high, the net income gets lower and the property value decreases. So a big line item as the guys talked about earlier, the insurance rates have gone way up and it's making property values go down due to the high costs of insurance.
Amy Menist:That's a perfect segue into our next point. So with that said, how do insurance companies value real estate?
Neil Axler:So there's a big difference between replacement cost and market value, but let's back up and let's do, let's define insurance value via the dictionary of real estate appraisal Institute volume seven. It is the cost of total replacement of destructible improvements to a property may be based upon replacement cost rather than market value. And then Robert, why don't you take the Marshall and Swift definition?
Robert Meulmeester:Yeah, so Marshall and Swift is a source that we rely on a lot when we do these type of valuations and we'll actually be talking about it in a little bit as well. They also come up with an insurable value definition which reads as follows, value used by insurance companies as the basis for insurance, often considered to be replacement or reproduction, cost plus allowances for debris removal or demolition less deterioration and non insurable items, sometimes cash value or market value, but often entirely a cost concept. And I guess that's sort of the gist of what we're talking about when we do insurable values cost based
Neil Axler:And then we want to really understand that its insurable value is not the same thing as fair market value. Fair market value is defined as the price in which a property would change hands between a willing buyer and a willing seller either being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.
Robert Meulmeester:And maybe just to mention one more thing about this is that when you look at this particular definition, it is very much driven by a transaction we're talking would change hands between a willing buyer and a willing seller, which obviously is so different compared to an insurable value because with insurable value you don't have an actual transaction taking place and I guess that is sort of what leads us to what we're trying to do for insurable value.
Neil Axler:Why don't you take this next one, Robert?
Robert Meulmeester:Sure. So insurable value methodologies, what we're trying to get accomplished here is to determine the maximum amount of money in an insurance company will pay out to replace an insured item if it's lost or damaged. And what we're trying to accomplish here is I guess together with the insurer and the policy holder is that there isn't a common understanding of what that value is in terms of what then could lead to a fair settlement in case of damage or total loss. The methodologies that we apply do depend on what insurance exclusions are or perhaps additions on the basis of either specifically included or excluded from coverage by the policies and its riders and endorsements. So that's a lot of legal stuff obviously that insurers will apply in terms of when you are trying to get something insured and also other parties that may be involved with it, like lenders as they want to make sure that they are safe from a collateral point of view. Of course in the end the higher the insurable value, the higher the insurance premium,
Neil Axler:So the insurable value represents the cost to rebuild and that can be higher or lower than the market value. Therefore you have to understand that insurable value does not include the value of the land and the preferred methodology in which we use for our appraisals is a replacement cost new method. Robert, you want to talk about actual cash value method?
Robert Meulmeester:Yeah, and actual cash value method is sometimes also something that comes up as insurers want it or those that are going to be insured prefer it. It's the cost to replace less. An amount for fiscal depreciation and obsolescence or by the fiscal depreciation is not the same as financial depreciation. Financial depreciation is more like your typical depreciation you do for gap or tax accounting. This is all based on wear and tear and the age and the obsolescence. It's probably fair to say that actual cash value is more something you'd see with personal property like you totaled your car, then it's quite likely that what you're going to get back is not a fully new car, but it's going to be that amount of money that your car would've been worth at the time of the actual event. But that can also be the case for say a repair of a roof, say a roof is damaged maybe especially if your roof was really old and was about in need of being replaced and insurer is not necessarily going to pay you money so you have your roof fully replaced. Maybe it's only that portion in connection with how old your roof actually was. We noticed though that for work that we do, which again is very much aligned with financiers but also business owners that obviously an actual cash value would not really make any sense because what are you going to do with half a building, right? So you want to get a whole building to be replaced and so therefore typically we will rely on replacement costs.
Neil Axler:No, that's great Robert, I'm going to move to the next slide now and I appreciate you bringing up the totaling your car. I have seen you drive before, so that's something. So replacement costs new method. The replacement cost of a building is a total cost of construction required to replace a subject building with a substitute of like or equal utility using current standards of material and design and that's really the key. What are the current costs and that's rising these replacement costs so much through the years and especially since covid. So the costs include labor materials, contractors, profit, overhead plans, specs and so forth. So the replacement cost new. When we do appraisals we typically utilize cost manuals or we utilize actual construction costs. We review quotes and we have discussions with builders and contractors. Considerations must be made for local building codes and unique features that are part of the building such as the heating and cooling and certain security features. And then for special use properties you need to look into say a clean room or something like that and then you need to make adjustments for whatever policy the policy calls for what can be included and what needs to be excluded.
So what typically is excluded when you're doing the replacement costs new typically you do not include preparing site for construction foundations, site improvements, and you also do not look at the original architecture plans when you're not going to include those costs for replacement costs. New you do include what would be the cost for partial demolition, any gutting or debris removal, and then what would the cost for site clearing and reconstruction be? So additional considerations, as I just mentioned, construction costs and if the guys mentioned earlier, they've significantly increased since 2020 and that is part of the reasons that you're seeing the insurance values getting so high. Also, you need to consider the construction timelines. They can vary depending upon the size and the complexity of the building. You need to estimate time, how long will it take to recover from a claim, how long will it take to clear and remove debris and replace damaged buildings and get back to business as usual. Robert, are you back? I think so,
Robert Meulmeester:Yeah, I'm back. I'm sorry, the system. Okay,
Neil Axler:We moved on without you but if you want to jump in at this slide right now.
Robert Meulmeester:I do like to jump in really quick but just to sharing a little statistic. So 2020 was obviously the year of covid and then so many disruptions obviously were created as we all recall from back in those days, factories that shut down logistics that was totally disrupted and in the end, replacement costs of buildings increased like a 45% over 2023 timeline, whereas when you compare it with your typical inflation, that was around 15% as we recall. There was quite a bit of inflation but it was still not the same as what happened with construction materials and so forth. So that had such a big impact obviously and something that really needs to be considered and in fact probably also resulted in people being underinsured, which of course necessitates the need for making sure they can have current appraisals, which then captures the increased replacement costs new appropriately.
And we noticed with various clients that we have worked with that oftentimes that were very, very surprised to see that these numbers went up so much and all we could do is just apologize for the fact that listen, construction costs simply have gone up so much, but you don't want to be in a situation where you're underinsured obviously, and you don't want to be in a situation where your coverage is not up to snuff in case of a situation because once you get there and a situation happens and a loss has occurred, then obviously it's too late and then your compensation may not cover the losses. Robert,
Steven Edelstein:Sorry, I did want to chime in for a second on the insurance perspective from here. So a lot of times if you don't insure to full value, the insurance carriers will place an endorsement on your policy, which will limit the amount that you'll receive when there is a claim. So the endorsements are really important to take a look at when it comes to replacement costs as well. So thank you.
Neil Axler:No, that's good. I was just going to jump in that the clients oftentimes were upset with us when they got back our reports, but they weren't nearly as upset with us as they were with the insurance brokers. You guys got the gist of the pain there. Robert, you want to move on to the next slide?
Amy Menist:That actually brings us to our next polling question, Bella.
Bella Brickle:Poll #4
Amy Menist:Neil, Robert, we did get a question in that says, how do you take in consideration the materials used in the building? So if it's a new construction by example or a science lab even?
Robert Meulmeester:Yeah, that's a great question and actually we actually end up working on something where the war indeed, for instance, clean rooms and the way the clean room was eventually valued was by sort of taking a building in a building and you have your core shell, which is one portion of the building, but then you also have your clean room, which is another portion of the building. So you have essentially two buildings together almost. We typically rely on a source that was featured previously, Marshall and Swift, so that is where we get a lot of the information from Marshall Swift published by CoreLogic. They show numbers for various types of buildings and they also go in a cost segregation mode where there is a unit in place cost which then need to be modified for location and time and all that good stuff.
Amy Menist:Great, thank you. So the preferred method for insurable value is applying the replacement cost new method of the cost approach. Okay, which actually brings us to our next part, Neil and Robert, can you please explain for the viewers what due diligence is and how it plays a role in an insurance appraisal?
Robert Meulmeester:Sure. Due diligence is essentially the process of doing a thorough, thorough investigation and that may be especially relevant when you are in the process of buying a building but also in those cases when something needs to be financed. So you want to do that thorough investigation, the due diligence to ultimately minimize the risk and then the potential cost that could come out of not being as careful with those potential risks. So the insurance appraisal should actually help in providing some insight into the coverage of a property and outline its risk profile and then the potential liabilities. Now for financing, a lender typically always requires to mitigate risk in case of damages to have an insurable value to be included aside from the market value. As you know when you try to get financing, a lender always wants to have fair market value, the type of value that we talked about earlier.
That is typical when you do a transaction. However, in case of insurance and in case of due diligence, you want to have that insurable value included as well and particularly those lenders that are more like your typical bank lenders, the typical, the more typical as opposed to private equity lenders, those definitely want to have that included. Additionally, that can be part of your due diligence is to actually have a property condition assessment conducted to better understand the various items that are in the building and then to understand the longevity of those particular items. For instance, the roof or a fire suppression system or the elevator or the other mechanical systems like the heating and cooling and so forth.
Neil Axler:It's also important, Robert, just for your due diligence to do the property condition assessment, so what kind of capital reserves that you're going to have to undertake that's going to affect the expenses of the property past year one that's really important and you want to talk about Robert Urban Land Institute, you're a big cheerleader for Urban Land Institute and they have something here.
Robert Meulmeester:I'm a huge cheerleader for Urban Land Institute and it is a focus of the Urban Land Institute to look into resilience because resilience is essentially what you try to achieve of a property so that that property has the ability to prepare and plan for, absorb, recover from and more successfully adapt to adverse events, which is so critical these days, especially when looking into matters related to climate change. Because when you think about issues like natural disasters whereby we see the likelihood of extreme weather increasing, then the necessary efforts to get to a resiliency will pay off. And then think about in essence, what do you want? You want to have a property that's on stilts so that when you have flooding and so forth that it doesn't impact the property as much. You want to have a property that is built with non-combustible materials. You want to have a property that is properly laid out with fire suppression systems. You want to have a property where your mechanical systems perhaps are not located on the first floor or even the basement, but actually at higher levels so that in case of water issues, it's not going to impact you as much.
Other matters that are relevant here are obviously the type of property that you have, the type of occupancy, which is something that was actually earlier already mentioned by our colleagues and when you have a restaurant versus an office, well obviously you want to make sure that your fire re is in order and when you have a vacant property you have additional risk associated with theft and other security matters. So in order to mitigate those type of matters, you want to have systems in place that can appropriately take care of that. We talked about other matters too, like inflation, which of course is not something that can easily beat, but it's something to plan for. Regulation in terms of code is set and how things are changing and then the litigation, which also has an impact on how you can do business. Great,
Amy Menist:Thank you Robert. That said, that actually brings us to our next polling question, Bella.
Bella Brickle:Poll #5
Amy Menist:Okay, thank you Bella. So we've talked a lot about the current state of the insurance marketplace and how catastrophic weather events, inflation and insurance claim costs are driving the market. We've also discussed that the data the underwriters use including construction, occupancy protection and exposure data in order to assess profile risks through catastrophic modeling as well as ways to improve a risk profile. We've outlined the approach that used to determine an assets of real estate's fair value and how insurance companies value real estate and the importance of performing a due diligence. So can you please pull this all together and can you explain for our viewers the impact that climate risk and insurance have on real estate fair market values? I'm going to start this off with Steve and Michael, can you please on behalf of risk strategies explain?
Steven Edelstein:Sure, I'll jump in here and we kind of talked about it already, but there are certain aspects of the commercial real estate transactions that are being impacted by insurance issues. Lending has become more and more difficult because these carriers, sorry, the lenders are asking for more and more information and it just generally we see a lot of coverage requirements that are being put into place that were not required in the past as a result of a lot of the events that are going on from a climate perspective. You'll just jump to the next one please.
That has arguably impacted the number of the difficulty it is to transact. So we're seeing a little bit less transactions go through than in the past. From our perspective, we deal with the buyers and sellers, so that has kind of thrown a little bit of a wrinkle into getting deals done as well as the insurance premiums going up due to everything we kind of said already on this particular call. So there are proactive steps that we can take to help you improve your results, which we kind of outlined already, but it's getting tougher and tougher if you're not going above and beyond to get the results you want from the insurance companies.
Amy Menist:I thank you Steve. So I'm going to switch this over. I'm going to let Robert and Neil take over. How do you see the climate risk and insurance impact on fair market value?
Neil Axler:Okay, let's start. The increasing impact by natural disasters does decrease the ability to get good insurance coverage. Our group does work all over the country from tornado alley in Oklahoma to earthquake fault lines in California to volcanic ash affecting crops, macadamia crops when we're valuing stuff in Hawaii to, it's a 20th anniversary this summer, August of Katrina in New Orleans. And then obviously what just happened tragically with the wildfires in Californias. So with these, as they were just saying, with these premiums increasing coverage limitations, there's a lot more risk, a lot less deals steals being done. Robert, you want to jump in on this slide?
Robert Meulmeester:Yeah, no, I mean I can just echo what you just said. In terms of the, I would say primarily a short-term negative impact on value as we talked about earlier, obviously insurance premiums have gone up which negatively impacts net operating income. So when you do a market or an income approach, then obviously your value goes down because you have so much more in expenses. And aside from that, there are also areas where insurers don't really want to be anymore. They have left the marketplace. We understand that that's also because of certain state regulation whereby insurers as they have to increase premium need to get I guess permission and then if that becomes too complicated for them, a reason to leave. So yeah, the short term result is a downward pressure on fair market value. I would like to look at the bright side though, and that is that when we look into the future, I mean sometimes bad things happen and then as folks look into solutions as solutions may happen where you can,
Neil Axler:There's some optimism here, right, Robert?
Robert Meulmeester:Exactly.
Neil Axler:There's optimism. This is a photograph of the city of Philadelphia, fly eagles fly, but talk about resilient buildings and all the things that could be good coming from this,
Robert Meulmeester:Right? What happens is that with changing building codes and obviously builders looking into other ways to build to be more resilient to these type of horrible events, you may end up with a totally different situation where things will become easier to ensure. Again, because it doesn't mean that when you have a big storm that the property is gone. So with better resilient buildings, they will then benefit obviously from demand and also financing. As financiers will see a mitigation in risk, then those options will increase and will become better, which ultimately should have a more stabilized and upward pressure on fair market value.
Amy Menist:Great, thank you guys. This actually brings us to the q and a portion of our webinar and I'm actually very happy to see that we've had a lot of questions come in. So our first question is, I'm going to start with Steve and Michael. What are some alternative risk financing strategies for insurance and how do they differ from the traditional guaranteed cost approach?
Michael Marinelli:Thanks Amy. Well, when you look at it in insurance program, a guaranteed cost program is going to be your most expensive because you are paying the most premium to assume no risk. So the insurance company from dollar one is going to take all of the risk. Then you can start moving into things like a low deductible option. So let's call it $10,000, $5,000, $15,000. That is going to put some skin in the game for you and your company and your properties and ultimately you will retain a little bit of risk and you might get a slight break in premium. The next step up from that would be a large deductible or a high deductible program. So you're thinking deductible is 250,000 on each and every claim, 500,000 on each and every claim, a million dollars on each and every claim. That is going to significantly reduce your premium because you are now significantly increasing your skin in the game and your risk with that typically comes collateral requirements.
That is something that we do all day and can help you and your clients with as well. Then the next step would be a captive. So a captive structure is you're basically starting your own insurance company. You have to fund those losses. It is expensive to get off of the ground because you do have to pre-fund a lot of your loss fund and then there's some admin expense in there as well. And ultimately what's great about captive is there are tax benefits to that, but you are in more control of your insurance program. It's your third party administrator who's adjudicating the claims and that gives you more control of your insurance program. And then ultimately when you're looking at companies like Walmart and Target companies like that, they're just completely self-insuring, meaning they do not buy primary insurance coverage and they cover dollar one their losses because for organizations that large insurance would just most likely be too expensive.
Amy Menist:Great. Thank you Michael. Alright, so I believe that's actually all the time that we have today. A reminder, if we didn't get to your question during our q and a portion, we will actually follow up with you after the webinar. I'm so glad to see there was so many questions come in. So thank you everyone for joining us and feel free to reach out to us if you have any questions at all. Now back to Bella for closing remarks.
Transcribed by Rev.com AI
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