How Real Estate Investors Use Climate Analytics to Navigate a Challenging Property Insurance Market

Soaring insurance costs are poised to become one of the largest threats to property profitability. Until recently, rising insurance premiums have been sidelined as a concern by real estate investors and underwriters due to strong market fundamentals.

With a cooling real estate market and a looming recession, insurance cost increases can no longer be offset by modest increases in rent or decreases in other operating expenses. Furthermore, extreme weather has depleted insurance reserves, setting the stage for another series of insurance rate hikes. Yet, insurance expense growth will not be uniform across markets and sectors.

Savvy real estate investors can get ahead of the evolving insurance landscape by leveraging climate analytics to screen portfolios for risk, assess insurance policies for sufficiency, and take advantage of dislocations caused by climate change.

Future Growth of Insurance Premiums in the U.S.

Insurance rates are increasing nationwide, but properties in climate vulnerable regions such as South Florida and California are experiencing the most significant cost escalations. According to USI, a leading insurance brokerage and consulting firm, premiums for properties outside of catastrophe-prone zones are expected to increase 5% to 10%, whereas premiums for properties inside catastrophe zones are expected to increase between 15% and 50% during the first half of 2023.

The rising cost of insurance will impact real estate investors differently. Real estate owners invested in property types like multi-family, condo, or hotel, will feel the pinch from premium growth the most because they cannot pass along insurance costs to tenants. By contrast, those invested in retail, office, or industrial, will not be as affected as much since tenants pay for insurance, either in part or whole.

A 2021 report published by SitusAMC, a global commercial real estate solutions expert, expressed two notable concerns related to current insurance underwriting practices. Firstly, there is a large disconnect between insurers and real estate market participants about the magnitude of future insurance premium growth. Although the report does not share the premium growth rates modeled by market participants, it can be inferred from USI’s wide range that there’s considerable market uncertainty.

Secondly, there is also a disconnect concerning the persistence of rate increases. The same report also notes that appraisers are only modeling a one-year spike in insurance premiums, followed by a return to the annual inflation rate for the duration of the holding period. However, with global insured losses exceeding historical averages, it’s likely that premium increases will continue to outpace inflation for the next several years.

In combination, the differences between the estimated and realized size and persistence of insurance cost increases will likely result in an overestimation of net operating income, implying future write-downs for commercial properties.

Climate Analytics to Screen for Risk & Resilience

Climate analytics serve as the first line of defense, helping real estate owners and investors identify exposure to high-risk locations. Properties that score high for climate risk are more likely to endure climate perils that will result in costly property repairs and a meaningful disruption to business operations;these high-risk assets are most susceptible to large and prolonged insurance costs increases.

Real estate investors should also consider the resilience of a location, or its ability to manage disruption from climate perils and bounce back into good standing. Quality of infrastructure, recovery spending, and the underlying economics of the surrounding community are all important factors that determine resilience.

Climate Alpha’s Resilience Index can score any location for climate risk, readiness and vulnerability.

Lastly, a sophisticated provider of climate analytics will allow investors to dissect their risk. In this regard, investors can break down climate risk by property-type to get a better idea of how much of the increase in insurance cost they will have to shoulder versus how much they can share or pass along to tenants.

Coverage Reduction and Policy Cancellations

Property insurers are not only increasing premiums, but they’re also reducing the degree of coverage provided. Examples of current coverage reductions include lower insured values, exclusions for water damage, and new sub-limits for named storms. Since commercial mortgage lenders require high levels of coverage, the new limits imposed by carriers may trigger a default or make some loans subject to costly, forced-place insurance.

Another way insurers are protecting their balance sheets is by terminating policies in high-risk areas. Since admitted insurers are heavily regulated by the state, they must receive state approval before passing along costs to policyholders. If the state denies them, the insurer eats the cost, leading many carriers to opt for policy cancellation. The policy-termination trend spells trouble for commercial real estate valuations, since without proper insurance coverage properties are not eligible for loans.

Climate Analytics to Assess Insurance Policies Sufficiency

Real estate investors can get ahead of the evolving insurance landscape by leveraging climate analytics to evaluate the sufficiency of their insurance policies. Climate data provides investors with a better understanding of what types of climate perils their properties are susceptible to and how the risk profile changes over time. Armed with this data, property owners can review insurance policies to ensure they’re appropriately protected. Since insurance contracts are renewed on a yearly basis, ensuring that coverage remains aligned with internal risk appetite as well as lender requirements will be a challenge.

An advanced climate analytics provider will also help real estate investors quantify the financial impact of climate volatility. In this regard, property owners can compare the climate-adjusted value of a property against its insurable value and take appropriate action.

Climate Analytics to Identify Market Mispricing

Savvy real estate investors can use climate analytics to not only manage risk but identify markets that present the greatest opportunity for risk-adjusted returns, turning climate risk to climate opportunity.

Since economic outcomes are strongly linked to both geographic location and the natural environment, climate analytics help investors identify high-performing locations that financial analysts would not have been able to identify using traditional research and deal sourcing techniques. Investors have an opportunity to share in more upside by using climate data to identify and invest in mispriced, climate-resilient locations.

Climate analytics empower real estate investors to navigate a difficult property and insurance market with confidence. By serving as the first line of defense, climate analytics help investors screen their portfolios for risk while simultaneously providing opportunities to take advantage of dislocations caused by climate change.

For more information on how Climate Alpha can help you get ahead of the impacts from climate volatility reach out to our team.