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Chipping Away at Insurance Costs

By preparing for hurricanes and other hazards, property owners can reduce premiums.

When Hurricane Ike struck Houston in September, Camden Property Trust's apartment communities suffered an estimated $1 million in losses, including downed trees and roof damage. After the storm, crews began clearing debris and making repairs and when power was restored, tenants who had evacuated began to return.

Camden, a REIT that owns 178 apartment projects around the country, was able to minimize disruption to tenants through careful preparation. Well before hurricane season began in June, the apartment owner organized teams of employees who prepared to notify tenants and distribute supplies. The REIT contracted with vendors who agreed to step in after a storm to make repairs.

“By careful preparation, we can limit losses — and encourage insurance underwriters to lower our premiums,” says Shawn Cox, Camden's director of risk management.

Whether or not they face hurricanes, many building owners are making an effort to control insurance costs. Property managers are emphasizing maintenance programs, which can help to lower premiums. The cost reduction measures are particularly important at a time when the economy is sluggish and profits are under pressure.

To reduce bills, owners should aim to improve buildings and persuade underwriters to reduce premiums, says Cox. A typical risk management program may start by making buildings safer, and installing reinforced roofs and durable windows.

After the improvements have been completed, owners supply information about the work to underwriters, who plug the data into models that predict maximum probable losses. Because reinforced buildings are less likely to suffer damage, the premiums often can be lowered.

Planning for emergencies

Camden ensures that all its buildings incorporate the latest technology to protect against storms. The REIT reinforces roofs and meets current standards for hurricane shutters. As an extra precaution, Camden periodically refreshes its portfolio, selling older projects and buying or developing new units that come with state-of-the-art hurricane protection.

Each of Camden's projects has detailed emergency plans, including evacuation routes and instructions for using sandbags. There are even guidelines for where to shelter pets. Each year, the detailed plans are carefully updated and presented to underwriters. “We market the plan to our current underwriters and to underwriters who might want to bid on our business in the future,” says Cox.

Owners who fail to provide underwriters with detailed data can be penalized, says Al Tobin, managing director and head of the property practice of Aon, an insurance broker. “If you don't supply data, the model defaults to the worst-case scenario,” Tobin says.

Simply supplying more data can substantially lower costs, he says. In one recent case, a risk model estimated the worst probable loss for a portfolio at $200 million. But by providing more data on roofs and safety procedures, the property owner was able to lower the maximum loss figure to $100 million. That decreased the annual premium from $6 million to $4 million, according to Tobin.

How to sway underwriters

While property owners encourage competition among insurance companies, they should view underwriters as allies, not adversaries, says Ray Macke, chief operating officer of Stream Realty Partners, which owns and manages properties in Texas. Macke says an individual underwriter may want to lower a bid and win business, but he or she must contend with tight-fisted senior managers. The task of the building owner is to help the underwriter make the case for lowering premiums, says Macke.

To give underwriters more ammunition, Stream Realty runs extensive training and safety programs for tenants and employees. In addition, the company carefully maintains and tests mechanical systems in buildings. All the precautions are then documented and presented to insurers.

While underwriters claim to follow rigid rules, they also have room to exercise judgment, says Macke. He says that when several insurers compete for business, there is often a 10% gap between high and low bidders, an indication of how much flexibility exists. “When underwriters feel comfortable with you and the way you run your portfolio, they can lower premiums,” says Macke.

Besides emphasizing safety, Stream Realty sometimes manages to lower premiums by accepting higher deductibles. Macke says that a $10,000 increase in a deductible can generate savings of that amount in annual premiums on his portfolio. Insurers look favorably on a high deductible because it can reduce their responsibility for handling small cases, such as a $5,000 claim that results when a tenants slips. Such minor incidents can be a significant burden for carriers who must send adjusters and process the paperwork.

Camden Property sometimes accepts deductibles of $200,000 or more. By taking that approach, the REIT manages small losses itself and uses insurers for catastrophic coverage. “Underwriters are very receptive to the higher deductibles because they see that we are active participants in loss control,” says Camden risk manager Cox.

Utilizing a single policy

Along with increasing deductibles, Cox aims to reduce costs by maintaining one blanket policy for all his properties. That way, the low costs of projects in Nevada help to offset the expenses of high-risk buildings in Florida.

By covering many buildings with one policy, owners can achieve substantial savings, says Jeffrey Alpaugh, managing director of Marsh and head of the insurance broker's global real estate practice. In their haste to purchase buildings, many developers rush to get coverage on the property without thinking through the best way to control insurance costs. “Buying insurance for one building is very costly and inefficient,” he says.

Covering an entire portfolio with one policy can be particularly important for owners with global portfolios. As real estate companies expand internationally and move into emerging markets, they face a variety of new problems, says Alpaugh.

Owners need to be aware that buildings can be damaged in civil wars or nationalized by governments. Marsh and other big insurance brokers specialize in helping clients analyze unfamiliar risk, says Alpaugh. Big companies such as ACE and Zurich offer comprehensive global policies.

For building owners shopping for insurance in the U.S. or abroad, the credit crisis may be a mixed blessing. On one hand, the slowdown in construction and new deals means less demand for insurance, which helps to hold down prices. On the other hand, pressure from lenders may be driving rates up. Wary of defaults, banks have been demanding more costly insurance coverage.

While some banks once accepted coverage from insurers rated A by Standard & Poor's, now the lenders are requiring policies from companies rated AA, such as Berkshire Hathaway and Chubb.

Such policies are expensive, and often hard to find. Some banks insist on more comprehensive policies, including, for example, earthquake coverage in areas not prone to tremors. “A couple of years ago, a building owner might have asked to use an A-rated insurer, and the bank might have agreed,” says John Racunas of insurance broker Lockton Cos. “These days, the banks can insist on AA coverage, and the borrower doesn't have much choice. You can't go to another lender because you are lucky to find even one.”

Relying on captive insurers

Instead of trying to reduce payments to insurers, some large companies aim to eliminate them completely by self-insuring. In a typical arrangement, the self-insurer sets up an insurance company known as a captive. Like any carrier, the captive charges the owner insurance premiums.

Each building in the portfolio is required to pay its share of insurance costs. Tenants are billed for their allocation. A typical captive would cover the owner's risks up to a set limit, such as $50 million. For losses above that, the owner would purchase reinsurance. A captive can cover a broad range of risks or a specific category, such as terrorism.

The owner of the captive is betting that losses will be low. When that happens, the captive will produce profits that can be sent back to the owner. Most often captives succeed in generating profits, according to a study by Marsh of 900 captives. More than 40% produced returns on capital of at least 10%. Managing risk is a key to containing the expense of coverage, Alpaugh says. “Companies with strong risk-control programs and effective captives can substantially reduce their insurance costs.”

Stan Luxenberg is a New York-based writer.

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