The costs of property insurance premiums have been steadily rising, bringing pain to owners of commercial real estate (CRE). Many factors contribute to increasing insurance costs, making it difficult for CRE investors to accurately forecast expenses. By understanding what’s driving price increases, CRE professionals can make smart decisions to mitigate risks.

Property insurance price increases spell pain for CRE

Key Factors Driving Insurance Price Increases

Several key factors are combining to push insurance premiums higher for CRE:

Increasing frequency and severity of natural disasters - Flooding, hurricanes, wildfires, and other catastrophic events are becoming more common and intense. Payouts to repair damage reduce insurer profits. Higher premiums help offset their risk.

Surging inflation - As the costs of materials and labor rise with inflation, it gets more expensive to rebuild after a loss. Insurers pass these increased costs on through higher premiums.

Low-interest rates - Insurers make money investing premiums until claims are paid out. Lower interest rates reduce these investment returns. Premium increases help compensate.

Rising reinsurance costs - Insurance companies purchase reinsurance to share exposures. As reinsurance gets more expensive, those costs get pushed to policyholders.

Growing liability risks - Lawsuits over issues like mold or asbestos exposure are increasing. Higher premiums help insurers cover these rising legal liabilities.

Increased regulation - New regulations require insurers to hold more capital reserves. Premium growth helps build these reserves to meet regulatory needs.

With all of these dynamics squeezing profits, insurers raise rates to maintain healthy financial margins. These increases make insurance costs less predictable for CRE investors.

How Gross Rates Are Calculated

Insurers use several factors to calculate a property’s gross rate for coverage. Key inputs include:

• Location - Risk profiles differ by geography. Coastal regions see higher premiums than inland areas less prone to hurricanes.
• Building characteristics - Construction materials, age, security, and other attributes help determine risk levels and rates.
• Coverage types - Policies with more comprehensive perils covered get higher rates than basic policies.
• Claims history - Frequent past claims can drive up rates due to higher perceived risk.
• Replacement value - The cost to reconstruct a property factors into required premiums.
• Deductible - Policyholders selecting lower deductibles pay more in premiums.
• Discounts - Credits like multi-policy discounts or storm shutters can reduce gross rates.

Insurers use complex models and algorithms to weigh these factors and calculate appropriate gross rates for each risk. The final rate also builds in administrative expenses, commissions, and profit margin.

Calculating Gross Profit on Insurance Policies

Insurance companies generate gross profit on policies by taking in more premiums than they pay out in claims and expenses. The formula is:

Gross Profit = Earned Premiums - Losses - Loss Adjustment Expenses

Earned premiums represent the portion of policies exposed to loss during a specific term. Losses reflect claim payments for damage coverage. Loss adjustment expenses include the costs of investigating and settling claims.

With a large pool of policies, insurers calculate average expected losses and required premium levels to achieve target gross profit margins. Individual policies may lose money, but profitable ones are subsidized enough to maintain overall profitability.

What Determines Insurance Rates?

Insurance rates reflect the cost of assumed risk. Companies quantify risk using data and tools like:

• Actuarial science - Statistical models predict claim frequency and severity
• Geospatial analytics - Identify high-risk locations based on past losses
• Weather predictive modeling - Estimate future catastrophe likelihood
• Building underwriting - Assess construction risks like materials used
• Claims analytics - Review historical loss patterns
• Reinsurance rates - Account for costs of shared risk

Insurers combine insights from these risk assessment tools with business expense forecasts to scientifically determine rates. However, art comes into play too, as subjective judgment is used to set final prices.

Impact of Rate Changes on Insurance Policies

Insurers typically adjust rates on an annual basis for existing policies at renewal. Significant increases can stem from shifts in reinsurance, new loss data, or inflation. Decreases may result from improved risk management or overpricing.

For the policyholder, increases mean paying more each year for the same coverage. Decreases provide savings on the cost of insurance.

Rather than waiting for renewal, insurers can also impose rate changes through:

• Re-underwriting using new information
• Endorsements altering terms mid-policy
• Applying mandatory regulatory changes

Since costs impact affordability, CRE investors model insurance expenses closely. Unexpected rate hikes can negatively impact property income projections.

Coverage Ratio Concept in Insurance

The coverage ratio measures an insurance policy's ability to pay potential losses. It compares the sum insured to the property's actual replacement value.

Coverage Ratio = (Sum Insured / Replacement Value) x 100

For full protection, the coverage ratio should equal 100%. A ratio below 100% indicates being underinsured.

Getting accurate property valuations is key but can prove challenging. If rebuilding costs rise, the stated sum insured may no longer be sufficient to cover a total loss. Reviewing valuations annually helps maintain proper coverage ratios.

Calculating Adequate Coverage Value

To calculate adequate coverage, commercial property owners need a replacement cost appraisal accounting for:

• Building construction materials and quality
• Specialized systems like HVAC, electrical, plumbing
• Auxiliary structures like garages, pools, and landscaping
• Removal of debris expenses
• Increased compliance costs for current building codes

An appraisal gives the full replacement value. The optimal sum insured equals this appraisal value. Carrying inadequate insurance leads to paying uncovered losses out of pocket. However excessive coverage wastes money on unnecessarily high premiums.

Formula for Life Insurance Sum Assured

Life insurance's sum assured is the guaranteed death benefit. It represents the policy's coverage amount and is calculated via:

Sum Assured = Annual Income x Policy Term x Multiplier

The annual income is the earnings to replace if the insured dies. The policy term is the length of coverage in years.

Common multipliers range from 10-25x annual income depending on age. Younger insureds use higher multipliers due to more years of lost earnings potential.

Reasons for Increasing Life Insurance Cover

Life insurance needs to evolve, so policyholders may need to increase coverage via higher sums assured. Common reasons include:

• Marriage or new children
• Major purchase with long-term debt
• Starting a business venture
• Inheriting estate tax liabilities
• Income increasing substantially
• Health declining, making future coverage difficult

Carefully managed policies offer options to increase the death benefit. Review needs annually and discuss increased cover with advisors when life changes.

Maximum Sum Assured in Life Insurance

While minimums exist to purchase a policy, maximums depend on each insurer's risk assessment. Factors include:

• Age - Lower death benefit limits for older applicants
• Income - Higher earners can justify larger sums assured
• Health - Those with medical issues may face lower maximums
• Net worth - Wealthy buyers have higher limits
• Occupation - Hazards like military service restrict amounts
• Existing coverage - Total insurance with all companies

Insurers want to limit payouts after a death. Evaluation of the above factors results in a customized maximum sum assured for every policy sold. Buyers should maximize cover within these limits to fully protect dependents.

Key Takeaways

• Rising premiums from natural disasters, inflation, and other factors make property insurance costs unpredictable for CRE investors.
• Insurers calculate gross rates based on risk factors like location and past claims. Profits come from earned premiums exceeding losses.
• Key determinants of insurance rates include actuarial analytics, weather models, claims data, and reinsurance expenses.
• Coverage ratios compare sums insured to actual property replacement values. 100% indicates full coverage.
• For life insurance, the sum assured is calculated by multiplying annual income by a factor based on age and needs.
• Maximum sums assured differ by applicant based on age, income, health, wealth, and other considerations unique to each individual.

Property insurance rates have been rising, creating challenges for commercial real estate (CRE) investors who can't easily predict these expenses. Key factors driving the increases include more frequent natural disasters, inflation, low-interest rates, rising reinsurance costs, increased liability risks, and tighter regulations.

Insurers calculate a property's gross rate based on the location, building attributes, policy coverage, claims history, replacement value, deductible, and discounts. Premiums collected must exceed losses and expenses to generate gross profits.

Examining past claims, weather models, actuarial statistics, and reinsurance prices helps determine pricing. Rate changes typically happen at annual renewal, but insurers can also re-underwrite or amend policies mid-term.

The coverage ratio compares the property's sum insured to its full replacement cost. A 100% ratio provides complete protection. Accurate valuation is key but can prove difficult, so regular appraisals are important.

For life insurance, the sum assured equals the income to replace multiplied by a factor based on age and needs. Reasons to increase a policy's sum assured include major life events like marriage, business ventures, or inheriting estate taxes.

Insurers assess applicants based on age, income, health, net worth, and other factors to establish customized maximum sums assured. Policyholders should maximize cover within their limits.