The cost of insurance has risen dramatically in recent years, and in some markets it is less available. As a result, residential and commercial property owners and their lenders face financial uncertainty and new degrees of risk to their operations and lending portfolios. At a ProSight Annual Risk, Compliance & Fraud Virtual Conference session, panelists said the current environment calls for a renewed focus on third-party sources of data and a more complete understanding of how the cost and availability of insurance affects financial health.
Insurance and Other Costs Are Rising
Many expect the trend of rising property and casualty insurance to continue. First Street Foundation, a climate risk research organization, forecasts approximately $1.5 trillion in net property losses—that is, uninsured losses borne by borrowers and their lenders—over the next thirty years. Donald Sheets, a lecturer in real estate at Harvard’s Graduate School of Design, said that “at least for the next three years, we will continue to see double digit price increases” in many residential and commercial real estate markets. Such increases are likely to be “much larger than banks and owners probably realize,” said Sheets.
Compounding these price increases is the shrinking availability of commercial and residential insurance in some markets. “Coverages continue to be dropped in the housing and commercial markets, while competition continues to decrease in terms of where you can get quotes,” Sheets said.
In response, lenders should redouble their efforts to track and monitor the insurance coverage on their loan portfolios. “This is why it’s important to have good process and procedures built around the tracking and monitoring of borrowers’ insurance, whether you’re doing that internally or using a third party to have the controls around identifying insurance risks,” said Mike Dimas, a senior vice president at Proctor Loan Protector. “The controls around the management of the tracking and monitoring of the coverage are going to be critical going forward. The key here is to identify whether coverage is in place, and does it meet the requirements that are set upon that loan.” Dimas cited data sources from Fannie Mae and others for analyzing replacement costs and called for licensed property and casualty professionals to inspect commercial and residential locations. “We have an obligation to our community, our insurance community, that they are properly insuring from the start” and throughout the life of the loan, Dimas said.
Educating the Buyer
The panelists concurred that the current insurance market requires buyers of property (and therefore insurance) to be especially aware of—indeed, well-educated on—the implications of the highly dynamic insurance market and long-term costs to their financial health.
“We talk a lot these days about the education of the borrower,” Dimas said. “Ten years ago, insurance was simple: I buy it, set it, forget it, and don’t have to worry about it. Today, we often say ‘there’s no such thing as a fixed rate mortgage anymore.’ Because the reality is you might have a fixed payment to the bank for the actual mortgage, but your taxes and insurance are increasing.” Meanwhile, when property values continue to increase, buyers must insure more at a higher rate. Accordingly, Dimas said, “we’re seeing a bit of a boom now in the home equity line of credit (HELOC) lending space as people take money out against their equity to help pay for some of these costs,” and they’re often able to do so because they have such low interest rates on their mortgages.
Similarly, in some cases “tariffs are increasing costs,” said Robin Ingari, executive vice president and executive credit risk officer at American Bank in Austin, Texas. “When a borrower goes to rebuild or is building the first time, some of those costs were not expected. And with other materials coming from different parts of the world, it’s very difficult to understand just what it really costs to rebuild.” Although real estate is appreciating in some markets, “property values may well be decreasing in others,” Ingari said, while replacement costs driven by labor and material inflation may be going up. “There may be a mismatch there, and that’s something you need to talk about with your borrowers.”
The Dilemmas in the Details
Panelists also discussed how rising insurance costs—and the steps that borrowers take to mitigate them—are likely to affect underwriting in the years ahead. Faced with higher insurance premiums, Dimas said, property owners may well “call their local State Farm guy they’ve been working with for 15 years and ask, ‘how do I keep this down?’” After reviewing the policy, the carrier may increase the deductible in an effort to keep premiums low and to meet lender and carrier coverage requirements. “But,” Dimas said, “what does that really mean to the homeowner? The valuable point here is that people may not even understand what they’ve just purchased.”
A high deductible could be difficult for a property owner to cover and imperil their chances of keeping up with mortgage payments, increasing a loan’s credit risk. The problem is magnified if a commercial property owner has deductibles rise on several properties, Ingari said, and some borrowers “may not realize their deductible has increased.”
Other changes that could help keep premiums lower need to be watched, too, Ingari said. Some insurers have policy-inside-a-policy approaches that set a higher deductible for, say, a roof. The financial allowance for alternate living arrangements during a long repair or rebuild can make a difference as well, she said.
In today’s insurance market, Ingari said, it could be that “until something happens, you don’t know what you have.”
