By Chris De Reza
Illustration by Michael Morgenstern

Over the past year, rising insurance premiums, reduced capacity and increasingly restrictive coverage have pushed insurance to the forefront for many participants in, and observers of, the real estate industry. Beyond the expression of interest in the extent of terrorism coverage, analysts and investors have begun to explore more deeply the types of coverage and related risk real estate companies undertake when making investment decisions.

Escalation in insurance costs due to the threat of terrorism, price increases brought on by a decade of poor underwriting experience and specific claims from exposures such as mold are having a market—changing impact. In most cases, real estate companies are looking at paying more for less when it comes to insurance coverage.

The insurance environment has changed dramatically and some investors are increasingly interested in receiving proper and timely disclosures regarding a company’s exposure and the effectiveness of a company’s risk management strategies.

The Insurance Landscape

While terrorism coverage has been a hotly debated topic, real estate companies have faced a hard market for other lines of coverage as well. Most underwriters today are imposing higher deductibles, lower limits and restricted coverage terms and conditions for property and casualty coverage.

“With premiums increasing, deductibles skyrocketing and coverage being restricted, the current insurance environment has created a ‘perfect storm,’” says Eric Schake, managing director of the National Real Estate Practice for Marsh, Inc. “This storm may be trouble for the real estate firm that is not prepared and proactive with their insurance and risk management programs.”

However, even though prices are up across the board, premiums don’t look so steep compared to prices 10 years ago during the last hard insurance market. Relatively low prices have prevailed in the insurance market for the past decade with some exceptions. Following heightened prices at the beginning of the 1990s, the market went into a soft period where prices dropped to extraordinarily low levels. The insurance industry was in a state of consolidation, leading to reduced costs, and many large companies were gaining strong returns in the equity market.

According to Sheryl Bittick, corporate risk management officer at Weingarten Realty Investors (NYSE: WRI), insurance premium prices have doubled since last year, but currently are comparable to 10 years ago. But it’s hard to quantify risk versus cost as the deductibles are higher than 10 years ago.

“We did an apples–to–apples comparison and found the rates today are about the same as they were 10 years ago,” Bittick says.

Rodger Davies, risk manager at AMB Property Corporation (NYSE: AMB), says that insurance costs per square foot have increased 70 percent over the last two years. But still, he says those costs are 5 percent below costs in 1998.

Also, for many lines of insurance the coverage is not as complete as it has been in the past. Whereas companies could previously purchase full and/or blanket limits for their entire portfolio, now limits may not cover the entire replacement value of the portfolio and be limited and, at times, inadequate.

Unresolved Issue

As challenging as the insurance market is for other lines of coverage, significant attention has been focused on the struggle to obtain a federal backstop for terrorism coverage. To date, what little terrorism coverage that does exist is severely flawed and extremely costly—sometimes accounting for up to half of a company’s total insurance expenses.

Insurers want in-depth analysis of the potential risks of certain property types and the industry continues to assess its insurers under a microscope, looking for the best deal.

“The stand—alone terrorism marketplace is inadequate in coverage and capacity,” Schake says. “It does not meet the needs of the real estate industry and is increasing the total cost of risk for the industry through higher retentions and premiums.”

Without adequate coverage, many lenders are unable to provide financing for the construction, acquisition or refinancing of projects. The lack of comprehensive and affordable terrorism insurance could also lead to a decline in property values and jeopardize investments made by thousands of investors and pensioners across the country, according to The Real Estate Roundtable.

The Risk and Insurance Management Society, Inc. (RIMS), which represents 84 percent of Fortune 500 companies and 950 small business employers totaling more than 4,000 commercial policyholders, recently surveyed its member companies in order to evaluate the terrorism insurance crisis. Of the 454 responses received, 71 percent found obtaining adequate terrorism insurance coverage very difficult or impossible. Additionally, 84 percent said they do not feel confident that their companies would be sufficiently covered in the event of another attack. And of the 80 percent surveyed who have renewed their company’s coverage, more than half do not have terrorism coverage included in their policy. Of all the companies surveyed, 65 percent currently have no terrorism insurance coverage at all.

While legislators and industry insiders say invariably the government will step in and establish supports for insurance liability as some foreign governments facing terrorism have, delays continue to arise. Both the U.S. House and Senate have passed terrorism insurance legislation, but the bills from the Democratic–led Senate (S.2600) and Republican–led House (H.R.3210) have significant differences and still need to mesh in order to be finalized.

The Senate and House appointed a conference committee prior to the August recess, but hopes for a quick resolution after the break faded when the issue of liability reform resurfaced. President Bush and Republicans are insisting that the final legislation not hold individuals liable for punitive damages in the event of a future attack.

As the committee continues work to iron out the differences between the two bills, the NAREIT–led Coalition to Insure Against Terrorism (CIAT) remains active in the efforts to see suitable legislation finalized.

In the meantime, real estate executives and investors are accepting more risk and realizing that everything tied to insurance simply takes more time. While there are many variables, insurance issues could play a major role in current and future development projects. “There will be no landmark construction until Congress passes some sort of terrorism insurance relief,” says David Wyss, chief economist for Standard & Poor’s.

A September study by The Real Estate Roundtable found that $15.5 billion in real estate transactions had been delayed or cancelled due to the ongoing lack of terrorism insurance coverage.

While the industry speculates over when a federal backstop will be approved, Steven Sachs, senior vice president and real estate practice manager at specialized insurance consulting firm Hobbs Group, says underwriters are beginning to better differentiate between the various types of real estate assets for catastrophic risks.

Different property types hold varying risk of terrorism, Sachs says. “Inevitably the rates will drop further, but to what degree is not clear,” Sachs says. “Some of the high premiums hitting certain property types are just not sustainable. Take sprawling shopping malls for example, where assets are spread out. The kind of attack that is anticipated on such a target is damage that would almost certainly be localized.”

Weingarten’s Bittick agrees that companies have had to look at the level of risk their properties hold and determine if the available terrorism coverage is worth the high cost. “We don’t have terrorism insurance on the strip malls. Lenders have required it, but when we called them and explained our position and the location and property types, they have agreed with us that this is a very low–risk target, if a target at all,” Bittick says.

Insuring Disclosure

With so many uncertainties in the insurance market, some investors are interested in companies disclosing the level of risk they carry. William Hauser, director and portfolio manager with HVB Capital Management, says investors have begun regularly asking questions relating to insurance coverage during quarterly conference calls—and company executives have been forthcoming in discussing their risks.

A study by The Real Estate Roundtable found that $15.5 billion in real estate transactions had been delayed or cancelled due to the ongoing lack of terrorism insurance coverage.

“In general, company management teams have been forthright in their quarterly calls and investor meetings about risk/insurance issues,” Hauser says. “It behooves the industry to be candid about the issue—otherwise the prospect of government assistance in addressing the problem fades. Several management teams have been more active than others in promoting the importance of a government response.”

To date, industry experts say there has been no indication from the Securities and Exchange Commission (SEC) that the agency is unhappy with the way most publicly traded real estate companies are disclosing risks. In fact, there appears to be a general sense in the industry that companies are not only disclosing what is within the boundaries of the law but are going further when warranted.

Some SEC filings today contain some risk discussion of what terrorism insurance will cost and if the property is insured, for example, for a biological or chemical attack. The additional information began appearing shortly after the Sept. 11, 2001 attacks and since has become more detailed, according to several real estate executives.

“Good CEOs probably tend to over–disclose just to be sure their shareholders are kept up to speed,” says John Robbins, chief executive officer of AmREIT.

“The SEC a few months ago made it clear it is expecting people to assess the insurance risk and be forthcoming,” Ettore Santucci, a partner with Goodwin Procter, says. “I have not heard they are unhappy with how the industry has behaved. Most companies have understood that they need to be clear, everything needs to be on the record.”

In fact, one expert says the real estate industry has made major strides in dealing with the new cards it’s been dealt since the terrorist attack last September.

“As something of an outside observer, I would say there has been significant risk management practiced in the real estate industry,” says David Mair, vice president for international development for the Risk and Insurance Management Society, Inc. and the former director of risk management for the U.S. Olympic Committee. “Real estate would stack up with the best of other industries.”

Disclosure Implications

Whatever SEC rulings materialize will have big implications for public company reporting in the years to come, according to Brad Markoff, a partner with law firm Alston & Bird LLP. Investors have a vested interest in knowing the levels of insurance REITs have for various properties and information regarding their dealings with risk management.

One company that expressed its concerns over renewing its insurance policy was Trizec Properties (NYSE: TRZ). In its 10–12B/A filing made on Feb. 2, 2002, Trizec reported that when its insurance policy comes up in December 2002, it may not be able to renew. Trizec is the same company that is slated to take over the Sears Tower in January 2003—and obviously investors may wonder how they would reasonably handle insurance issues related to the high–profile property.

However, the up–front disclosure that Trizec made in its filing is currently not required by the SEC. There is a subjective nature in the accounting industry about what exactly needs to be reported and some investors may think critical information is slipping through, according to Markoff.

As a testament to the subjective nature of explanation in SEC 10–Q filings, companies’ level of detail about terrorism insurance varies widely. Some REITs did not mention whether or not they had terrorism coverage in that particular filing, while others disclosed information about specific insurance and the current market environment.

In its 10–Q, Boston Properties, Inc. (NYSE: BXP) stated clearly that most property insurance providers no longer cover acts of terrorism under all–risk coverage. The company, which manages a high concentration of properties in New York and other metropolitan areas considered likely terrorist targets, goes on to report that they have secured terrorism insurance on a portfolio–wide basis for $250 million per occurrence. The company adds that bio–terrorism insurance is unattainable at commercially reasonable terms, but that it will continue to watch the market for new developments. The company lays out for investors the chance that it could lose both the income generated from the properties and be liable for mortgage debt if an event occurs that is not covered, such as wars or catastrophic acts of nature.

In its 10–Q, Equity Office Properties Trust (NYSE: EOP), which manages 767 buildings in 34 metropolitan areas, advised investors that increased costs for property insurance and safety and security would be high for the “foreseeable future.” The company reported any increases in security or insurance costs will be reimbursed by tenants.

The varied detail reflects the attitude that insurance costs are not a dominant issue in the grand scheme of most REIT–sized operations. “Insurance costs, while they have increased, still represent a small percentage of revenue so it probably gets the small attention it deserves,” AMB’s Davies says.

However, the insurance issue will remain in the minds of investors since availability—or lack thereof—of appropriate terrorism coverage will drive business and financing decisions, HVB’s Hauser says. “As an example, Boston Properties will probably refinance its more than $1 billion of debt (maturing before the end of 2003) in the unsecured market,” he says. “This move will impact earnings. Boston Properties has the benefit of attaining an investment grade rating and going this route. For some other entities that have relied on the secured market, the situation may be less clear.”