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HOT TOPIC: Crossing the insurance gap

Shopping center owners are bracing for their own unique struggle when it comes to staring down terrorism.

Faced with the largest increase in overall insurance premiums since the mid-1980s — by some estimates as much as 500% — owners now have difficult decisions to make about how to recoup their costs. Insurance is normally a cost of doing business that owners simply pass through to tenants in the form of common area maintenance (CAM) charges. But with many retailers on financial ropes of their own, their ability to pay higher CAM (or even rent) is in serious question. That scenario leaves more owners to eat the higher costs.

“All landlords are concerned, because they'd like to pass along as little as they can because the lower the CAM charges the more they can charge in rent,” says Bruce Guthart, chairman, CEO and president of New York-based Kaye Group Inc., a leading insurance broker.

Owners are so concerned, they're considering drastic actions. “I wouldn't be surprised to hear that landlords absorb some of the cost themselves to ease the burden on their tenants,” says Jeffrey Donnelly, vice president of real estate equity research in the Boston office of Wachovia Securities. “That may be a voluntary decision or not; if they push tenants so hard they close stores then it's all on their heads.”

Already the battle lines are being drawn. In late February, Simon Property Group won a temporary restraining order against GMAC Commercial Mortgage Corp., its lender on Mall of America, after GMAC tried forcing the company to buy a terrorism insurance policy for the mall.

By most accounts, the insurance premium price hikes are substantial. “Anecdotally, we're hearing that the large commercial real estate owners are bracing for a significant 15% to 25% increase in their annual insurance costs for 2002,” says Donnelly.

Other industry watchers predict similar increases. “Insurance rates for real estate companies have increased from 100 to over 300 basis points on new policies since 9/11,” says Merrie Frankel, vice president and senior credit officer at New York-based Moody's Investors Service. “A number of my accounts had already negotiated their new insurance policies before 9/11, so they have until later this year to deal with this issue. Exclusions for terrorism are now commonplace, whereas they were previously part of the intrinsic policy and not costly.”

Because the insurance industry is regulated by the states and not by the federal government, states are free to decide for themselves whether terrorism provisions can be excluded from policies. More than 30 states have passed such exclusions, but holdouts include California and New York.

While the bulk of the insurance industry's claims from the Sept. 11 attacks will be paid in New York, the events created a nationwide phenomenon.

“The reason 9/11 was such a crisis in the insurance industry was it was the first catastrophic event that affected all lines of insurance coverage,” Guthart explains. “Property insurance we know and understand — the buildings were destroyed. But it affected workers compensation insurance. Life insurance companies were affected. Liability insurance companies will be affected because there will be lawsuits on security issues down the road. The same thing can happen to shopping centers.”

Will small centers feel the heat?

Normally when catastrophic events like those of Sept. 11 occur, insurers can recoup their costs through higher rates passed on throughout their portfolios. That means smaller shopping centers may suffer right along with their larger brethren.

“For the smaller strips with 50,000 sq. ft. and less, you're probably looking at the 20% to 30% range for their insurance bill,” says Guthart. “As you get larger, they'll see larger increases. So the typical 100,000 sq. ft. strip is probably going to see increases in the 30% to 50% range. Then the major high-traffic malls will see larger increases because the insurance industry will perceive them to be riskier.”

Frankel agrees, noting that regional centers are more vulnerable due to their enclosed format and are perhaps more prone to attack. But smaller centers might not be immune from a rate hike. “One community/neighborhood shopping center executive recently apprised me that they could face vulnerability to terrorism through ‘mail-box’-type tenants, and explained that if one of the mail-box stores received an anthrax-laced letter it could result in closing down the entire center for clean-up,” says Frankel.

Ross Nussbaum, retail REIT analyst with New York-based Salomon Smith Barney, says malls will still feel the most heat when it comes time to pay their insurance bills. “We expect larger regional malls will see a larger increase in insurance costs than smaller neighborhood centers.”

Legislation to the rescue?

As of mid-February, the U.S. House of Representatives had passed bill HR 3210, a bill which essentially provides for the federal government to be a reinsurance “backstop” for future catastrophic events, giving insurers incentive to continue providing coverage at reasonable rates. But the Senate had yet to take up discussion on the bill.

A coalition of business groups, including the National Association of Real Estate Investment Trusts (NAREIT), the Real Estate Consortium and the Mortgage Bankers Association of America led the charge for the bill's passage, and continues to push the bill forward.

“I think there is a real chance we will see the federal government make some form of effort here, in part because the Bush administration is highly supportive of big business and in part because it is a well timed, emotionally charged and symbolic move,” says Tony Edwards, NAREIT senior vice president and general counsel.

Guthart is also optimistic. “Congress has to do something. They have to see the effect. Businesses haven't totally seen the effect in their pricing and so they haven't gone to their congressmen.”

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