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Windstorm Insurance Clouds CMBS Horizon

Spiking premiums and deductibles for windstorm insurance in coastal areas may pose a challenge for holders of loans rolled into commercial mortgage-backed securities, according to Fitch Ratings.

In the wake of the most expensive hurricane season ever in 2005, many insurers are reducing loss exposure in hurricane-prone areas by raising premiums and deductibles, and in some cases, dropping coverage amounts or eliminating coverage altogether, Fitch reported this week. That can create a dilemma for CMBS borrowers required to maintain insurance coverage under terms of their loan.

“CMBS servicers have noticed a sharp increase of anywhere between 25% and 400% in windstorm and flood insurance premiums since the official start of the hurricane season on June 1,” said Joseph Kelly, a senior director at Fitch. “This may present a problem for commercial real estate properties where premium increases cannot be passed through to tenants, and in fact the resulting value decline may be severe enough so a property can no longer support its full debt service, increasing the likelihood of payment default.”

As premiums increase, and in some cases even skyrocket, the same is happening to deductibles, as Fitch has seen increases of 10% to 15% of replacement value for renewals, compared to 2% to 5% last year. Some CMBS servicers are requiring borrowers to provide guarantees to cover the difference between the two deductibles in order to mitigate the additional risk.

Mortgages secured in CMBS typically carry property and casualty (P&C) insurance coverage equal to the replacement cost of the property. The majority of P&C insurance policies include wind as a covered peril, except for properties located in close proximity to the coast. Close proximity definitions differ by insurance companies and their risk appetite. For example, some insurance companies exclude wind for properties located within 20 miles of the coast, others 100 miles. When wind is excluded, a separate wind policy or rider needs to be purchased.

“Fitch's chief concern is that windstorm insurance along coastal areas may become commercially unavailable, possibly echoing in severity the terrorism insurance issues of late 2001/early 2002,” says Patty Bach, another senior director at Fitch.

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