Last Cast Letter #7: Insane Insurance

Hi All - Happy Monday. It’s the last day of the month, which means it’s time for the Last Cast Letter.

One of the topics I've been wanting to write about and examine for a while is potentially one of the least sexy subjects out there. But I think it might be one of the agenda items giving property owners and operators the biggest headaches this year. I'm talking about property insurance, and more specifically, the rapid rise in premiums.

It's top of mind for me since I'm in Florida and it's hurricane season. Yet, while it's an acute issue here – and one that could even sway the 2024 presidential race – premium increases are impacting millions of people across the country.

For property owners specifically, there are a lot of headwinds right now. On the income side, rents are slowing. Meanwhile, on the expense side, taxes are increasing and so are utility costs. Labor hasn't gotten cheaper, and plenty of owners/operators are going to be on the hook for more expensive debt payments thanks to floating-rate loans.

Layer on skyrocketing insurance costs, and suddenly few deals make sense. Unless, as I mentioned in May, you entertain the idea of a cash purchase and delayed refinance. Or you have a great broker who can help source off-market deals and/or you're working on a 1031 exchange. Triple Net leases also help, which is why Industrial has remained a relative bright spot. But at the end of the day, the costs get passed somewhere, to someone. I think this margin compression is going to lead to a lot of opportunities as the distress flushes itself through the market, but that’s for another time.

Zooming out, I want to take a look at why this is happening, how it's impacting the industry, and a few ways that individuals can save on home insurance. The "how you can save part" comes across as very personal-financey, which is not my goal. But I read an article while I was writing this and I thought it was actually pretty helpful so I figured I would include it. So let’s dive in and try to answer the question of why this is happening, starting with the wacky weather around us.

Climate

Since the beginning of the year, rates have increased dramatically in certain parts of the country. On average premiums have risen about 26% for multifamily properties specifically. Why? Well, one of the reasons that we hear thrown around the most is climate change.

Nevertheless, as I'm sure most of you already know, climate change appears to be the main culprit when it comes to increasing insurance premiums. Hurricane Ian caused $50-$65 billion in damages last year. The Camp Fire caused $10 billion in damages in 2018. In coastal Texas, some apartment owners have seen their premiums spike 300% thanks to hurricane and wind exposure.

(We’re also capable of self-inflicted wounds as a human species. The 2020 riots caused $1 billion in damage, for which many insurers were on the hook. Maybe we can chalk that up to a change in the political climate).

Climate change has been linked in studies to larger, more frequent wildfires. There are also some studies that show hurricanes grow stronger quicker and dump more rainfall now compared to the past. Sea level rise is leading to more frequent flooding as well. All of the aforementioned items lead to loss and destruction, which means that if people have insurance, those companies are now charged with processing the claims.

It appears the claims have become too much for some insurers to handle. This May, State Farm stopped accepting applications for business and personal lines of property and casualty insurance in California. Allstate also stopped new policy sales in the Golden State.

On the East Coast, Farmers Insurance pulled out of Florida. And in the middle of the country, companies like American Family Insurance are canceling master policies for apartment complexes in Colorado. The Mile High state has also grappled with fires, floods, and hailstorms. Besides the volatile weather, my home state is beautiful and actually gets more sunny days than Florida.

Ultimately, an increasingly erratic climate is a major part of this equation. Constant changes in the weather don't bode well for any sort of reprieve when it comes to insurance costs.

Replacement Costs

On a national level, the rise of "uninsurable places" is growing. As a result, more states are looking to follow Florida's lead and start state-backed providers. But this isn't always a simple solution. Citizens Property Insurance, Florida's state insurance company for the last two decades, has seen the number of policies rise about 50% in the last year alone.

Now, that might have to do with other insurers exiting the state and the increasingly capricious weather. It also has to do with the fact that Florida's population has swelled since the 1970s, and even more recently during the pandemic.

Guess where a lot of these new Floridians want to live? Next to the water. From 1970 to 2020, Florida's population density spiked by over 300%. In 2022, Florida was the fastest-growing state. A big portion of these new settlers landed along the coasts. This simply means that more people and property are in harm's way when storms barrel through the warm Caribbean waters.

As I mentioned above, labor and materials are more expensive as well, so when there’s damage, it’s more costly to rebuild. Additionally, for better or worse, property values have increased so what this means is that replacement costs have risen. Because property insurance is largely calculated using replacement cost value times a rate this means that premiums are also surging. Again, it’s just another piece of the rising premium puzzle.

Litigation Costs

Now, this issue might be Florida-specific, but it’s one I’ve heard mentioned in a few conversations. And I find it interesting because some studies point to it being a bigger issue than Florida’s weather and geography-related concerns.

According to a recent report from the Insurance Information Institute, Florida leads the US in insurance-related litigation. Despite accounting for less than 10 percent of claims, Florida makes up almost four-fifths (79%) of the nation’s total.

The report specifically starts by saying, “Florida’s homeowners’ insurance market finds itself in peril, and the reasons have little to do with the state’s hurricane exposure.” Sean Kevelighan, Triple-I’s CEO added:

In regard to the fraud issue, I’ve heard through the rumor mill that certain people in some Florida cities — and I’m sure elsewhere — love big storms, even if they don’t materialize into Category 4 or 5 hurricanes. As long as the storms are “bad enough”, sometimes windows still get “broken” or “damaged” during the night so insurance money can be collected for expensive, storm-proof replacements. Interestingly enough, the storm-proof windows lower future insurance bills as well.

Taken together, the litigation and fraud complaints create a hostile environment for insurance companies in states like Florida. This is probably why half of the billboards on I-95 are for big-personality lawyers and law firms.

Other Factors & Final Thoughts

The issues above aren’t the only factors driving premiums higher. They’re the ones that get blamed the most, however, and the ones I find the most interesting. Other factors include:

• Reinsurance costs. Insurance companies often purchase reinsurance to protect themselves against excessive losses from catastrophic events. When reinsurance costs increase (due to higher risks or claims), these additional expenses may be passed on to policyholders through higher premiums.

• Regulatory Changes: Changes in insurance regulations and policies can impact the pricing and coverage of property insurance. If new regulations require insurers to expand coverage or implement other costly changes, premiums may rise to accommodate these adjustments.

• Investment Income: Insurance companies invest the premiums they collect to generate income, which helps offset the costs of paying claims. Economic conditions and fluctuations in investment returns can influence insurers' financial positions and impact premium pricing.

• And finally, another catch-all scapegoat: Inflation: Inflation can affect the cost of rebuilding or repairing properties, leading to higher insurance payouts. Insurance companies may increase premiums to keep up with the rising costs associated with construction materials, labor, and other expenses.

Ultimately, over the past three to five years there has been a confluence of factors that has created a perfect storm to drive premiums higher. While some efforts are being made by certain states, I don’t see this issue being fixed in the short term.

This will likely put downward pressure on specific markets. Property owners may try to pass these increased costs along to tenants, but rents can only rise so much before people look for other places to live.

Rising insurance rates, along with other costs, could force certain owners to sell at much lower prices than they anticipated. While this is unfortunate for them, this also presents an opportunity for investors.

Ways You Can Save

I’ll end this edition with what I hope might be helpful for individuals and property owners. Again, I want to write about real estate here, not personal finance, but I came across this article and I found it helpful. You can read the full piece here, but these are a few things to keep in mind:

• Bundle, Bundle, Bundle: “That means buying your homeowners and auto coverage from the same company, which can save up to 30 percent.”

• Raise your deductible: “Moving to a $1,000 deductible from a $500 can shave your premium by 25 percent.”

• Report home improvements: “Anytime you replace old plumbing, add security cameras, or install gas or water-leak detectors, let your agent know. You may be able to trim off 2 to 6 percent with each additional item. If you live in a fire-prone area, even ​​cutting back dry brush around your home and outbuildings could generate a credit on your bill.”

So, there you have it. That’s what I’ve been thinking about this month. Send thoughts – good or bad – my way. And, as always, if you’re interested in investing alongside us, please fill out the investor form below.

— Brooks

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