cover story

Perilous Times: COVID-19 & Commercial Property’s Vexing Variables

Commercial property insurance was already facing its hardest market in 35 years. Then COVID-19 entered the scene.

The commercial property insurance line rang in the year 2020 in a precarious position. With rates increasing around 20% quarterly for large customers and predictions of yet another perilous year, the business of covering commercial structures and associated liabilities was already fraught with peril.

“It is as hard a market as I have seen in 40 years,” observes Gary Marchitello, chairperson of Willis Towers Watson’s North American property team. “I would have to go back to 1985 or 1986. It is that bad with no end in sight, and God forbid we have a big hurricane or two this year.”

Then came the novel coronavirus (COVID-19). Originally not expected to have much impact on the property-casualty insurance industry, it is spurring, in the words of Evan Greenberg, chairman and chief executive officer of Chubb Ltd. and Chubb Group, “the largest single loss in insurance industry history.”

The response to the pandemic turned business-as-usual upside-down, pressuring unemployment to the highest levels since the Great Depression. Besides challenging industry-understood policy language for business interruption coverage, tele-everything — whether for working, shopping or meeting — has at least temporarily reduced commercial property use.

From downtown’s towering office buildings to exurban strip malls, vacant and unmonitored structures mean greater physical risk, especially when civil unrest not seen since the 1960s continues amid an unconventional U.S. presidential election year.

And though weather-related losses usually make up the largest piece of property coverage losses, the struggling U.S. economy is exacerbating the financial pressures facing commercial property insurers. For instance, the historic 33% drop in the nation’s gross domestic product (GDP) during the second quarter of 2020 is hurting exposure growth in many key lines, while the Federal Reserve’s aggressive rate reductions are cutting into much-needed investment income.

The multi-fold developments this year call for property actuaries to recognize both positive and negative effects on commercial property insurance and to begin “thinking about risk and characteristics in light of the changes we have seen,” says David Bassi, managing director for Guy Carpenter.

A Collection of Coverage

Although commercial property is referred to as an insurance line, it is actually a collection of coverages bundled together as reflected in insurers’ statutory financial statements. Actual physical property damage can be covered under businessowners policies (BOP), commercial multi-peril policies or monoline property coverages such as fire and allied lines.

The response to the pandemic turned business-as-usual upside down, pressuring unemployment to the highest levels since the Great Depression.

 

In the marketplace, commercial property insurance rates have been rising similarly to most other commercial lines. After reductions from 2015 through 2017, rates experienced 2% to 3% year-over-year increases in 2018 for Willis Towers Watson’s upper-middle to large and complex accounts, according to data the risk management and brokerage firm provided to Actuarial Review (see Chart 1).

Then, in the second quarter of 2019, rates increased by approximately 10%, and by 22% for customers buying coverage during the fourth quarter. Since then, rates have risen 20% to 22% during the first two quarters of 2020 and are expected to continue increasing at this pace for the rest of the year, Marchitello predicts.

Even more strikingly, businesses with non-catastrophe (CAT) exposure are expected to see rate increases of 10% to 20% and those with CAT exposure of 15% to 25%, according to Willis Towers Watson’s “Insurance Marketplace Realities 2020 Spring Update-Property” report released in May.

Moreover, for companies with CAT exposure and losses, rate increases can be 30% or more, the report notes. In some “micro” markets with CAT exposures and losses, such as manufacturing, life sciences and retail, rates could skyrocket by as much as 50% to 300% or more.

Not surprisingly, underwriters are becoming more risk-selective, requiring greater loss mitigation investment as customers experience higher deductibles, according to Willis Towers Watson’s report. Shared and layered placements are also increasing, creating more complicated and longer renewal negotiations.

Loss Causes

Extreme weather events are a significant cause of commercial property losses. The year 2020 has a greater chance of large natural disasters, warns Robert Muir-Wood, chief research officer of Risk Management Solutions, Inc. (RMS). “Sea surface temperatures are high, and without an El Niño, we could expect more Atlantic hurricanes, as well as more intense storms than average.”

Insurance losses in 2017, the most expensive year on record for natural disaster losses in the United States, were $78 billion, and they were followed by another $52.3 million in 2018, according to Munich Re. While 2019 figures have not been finalized, the losses for the first quarter of 2019 amounted to $25.5 billion before last year’s hurricanes and wildfires once again left their mark.

Through the first seven months of 2020, there were already more than 10 separate events with economic losses (combined insured and uninsured losses) exceeding $1 billion, largely due to severe thunderstorms, tornadoes and hail in the Midwest and the southern portion of the U.S., according to the National Oceanic and Atmospheric Administration’s National Centers for Environmental Information. The number of losses with more than $1 billion in insured and uninsured losses continues to rise. In the past three years, the average is 14.7 per year; for 2015 to 2019, the average is 8.2; since 1980, the average is 6.6.

Although CATs get a lot of attention as property losses, they are not the whole story. “The sentiment expressed by (insurers) is CATs count, but most insurers would ascribe general rate inadequacy more to non-CAT events such as convective storms, fires and explosions,” Marchitello says.

There is some good news. Special property coverage, which includes fire, allied lines and inland marine, has been enjoying favorable reserve development for each of the past five years, according to Fitch Ratings’ report, “U.S. Commercial Lines Market Update,” released in June. Reserving in property insurance is “relatively easy,” Marchitello notes, because there is little or no incurred but not reported (IBNR) losses and loss events are reasonably ascertainable. “It is hard to fake reserves in property,” he observes.

As for profitability, Fitch’s report notes that the combined ratio for special property peaked at 117% in 2017 but dropped to 91% in 2019. However, commercial multi-peril, which includes liability and property exposures, has had a combined ratio above 105% in the years 2017 through 2019.

Another trend affecting property insurance is that the insurance industry is developing greater recognition of the role of climate change in driving loss potential. The year 2017 saw several examples of catastrophic loss events bearing the signature of climate change, Muir-Wood says. “As one example we have the unprecedented rainfall totals and intense flooding of Houston by Hurricane Harvey,” he explains. “Then we have the extraordinary 2017 wildfires in California at the end of a record-breaking heatwave, multi-year drought and extended fire season.”

In 2019, climate change topped cyberrisk as the most identified emerging risk in the “12th Annual Survey of Emerging Risks” survey of actuaries and risk managers (Actuarial Review, March-April 2019) and remained in the top spot for the 2020 survey. The Actuaries Climate Index, introduced in 2016, also contributed to growing awareness. Both the survey and the index are sponsored by the Casualty Actuarial Society, the American Academy of Actuaries and other actuarial organizations.

While climate change is not having a direct impact on rate changes, Marchitello says, it is influencing underwriting and investment activities affecting commercial property insurance. Some insurers, for example, have stopped underwriting and investing in mining and energy companies that extract or use fossil fuels.

“The effects of climate change on extreme events,” Bassi offers, “are nuanced, often difficult to detect, and in some cases still emerging areas of scientific research.  Changes in extreme events act over decadal timescales, which is important from a strategic planning perspective, while on a year-to-year basis, natural variability in extreme events is the dominant mode.”

A key question for actuaries, Muir-Wood says, is “how far we have moved away from the long historical record.” Rather than calibrate a model on 100 years of history, he suggests, “the last 10 to 20 years might be a more relevant baseline.”

The COVID-19 Surprise

As the commercial property insurance market continued its stubborn hardening into 2020, reports of a China-based novel coronavirus began to surface early in the year (Actuarial Review March-April 2020).

While the pathogen was beginning its rapid spread around the world, economic indicators in the United States were (still) looking good. The Dow Jones Industrial Average posted a historic high of 29,551.42 on February 12. Gallup reported that 90% of Americans were satisfied with their personal lives. And the unemployment rate was enjoying the fifth consecutive month of around 3.5% — the lowest in 50 years.

Through the first seven months of 2020, there were already more than 10 separate events with economic losses (combined insured and uninsured losses) exceeding $1 billion ….

 

That significantly shifted in mid-March. Lockdowns intended to quell the spread of the coronavirus triggered an economic domino effect, temporarily closing businesses and pressuring April unemployment levels to 14.7%, the highest percentage since the Great Depression in the 1930s.

“Nobody ever expected COVID-19 to affect commercial property,” Marchitello remembers. For actuaries, Bassi says, “COVID is one of those events that is creating challenges with assessing exposure.”

Second quarter 2020 insurance industry earnings provide a clue into losses so far. After tracking second quarter results for about 50 North American public insurers, “incurred losses from COVID total approximately $7 billion,” offers James Auden, managing director of Fitch Ratings, for the P&C insurance industry. Including the losses for Lloyd’s of London, large global insurers and reinsurers brings the worldwide total so far to $17 billion worldwide, which is “likely to go up in second half of 2020,” he adds.

Part of this will include claims for business interruption coverage even though many policies were not intended to cover pandemics. Since 2006, Insurance Services Office policy forms explicitly limited coverage associated with pathogens, but that has not been tested until now. Policyholders desiring infectious disease coverage can buy it as an endorsement.

Since COVID-19 emerged, however, several bills at state and federal levels have been introduced to change insurance coverage retroactively, but Marchitello says that the possibility of passage appears remote. Meanwhile, the constant stream of lawsuits continue, amounting to more than 1,000 so far. “The doom and gloom commercial property insurers are experiencing is about what could happen,” Marchitello explains. Preliminary rulings favor insurers generally, but it is still early. “We are metaphorically in the top of the third inning,” he adds.

Data concerning the impact of COVID-19 on property risk is sorely needed. Unfortunately, there is not yet enough information for actuaries to apply predictive modeling regarding COVID-19, says Stephen Mildenhall, assistant professor of risk management and insurance and director of insurance data analytics at the school of risk management at St. John’s University. “We don’t have enough data. We are more in the land of scenario testing.”

Property insurers also face another source of losses from historic civil unrest. When the number of COVID-19 cases had nearly reached its first peak in late May, riots broke out in reaction to the death of George Floyd under restraint by Minneapolis police. Damages from the initial riots are considered a catastrophic loss by Verisk’s Property Claims Service because they amounted to more than $25 million. Minnesota Governor Tim Walz requested $500 million federal aid for damage to public property.

Civil unrest continued during the next several weeks, spreading to 140 U.S. cities, according to the Insurance Information Institute, which reports an early estimate of $500 to $900 million in insurance losses so far. The expense pales in comparison to the estimated $4 billion of insurer losses from Hurricane Isaias in August estimated by Karen Clark & Company. However, how long riots, theft, and destruction of property will continue before the U.S. presidential election in November is a variable that could make the financial impact even larger.

Economic Consequences

Losses aside, commercial property insurers can be impacted by the economy in several ways. “Insurance premium and exposure growth are tied with growth in GDP,” though not perfectly, Auden observes.

One key economic measure is loan delinquency. First, it indicates commercial buildings that might not be protected or maintained, Marchitello says. Beyond the known risks of empty structures, such as unchecked maintenance, vulnerabilities leading to fires and pipe bursts, theft and arson, empty commercial buildings are also a harbinger of a struggling economy.

Mortgage-backed securities, which are bonds “that the industry invests in heavily,” are a troubled asset due to the economic strain resulting from the COVID-19 outbreak, Mildenhall says.

Beyond the known risks of empty structures, such as unchecked maintenance, vulnerabilities leading to fires and pipe bursts, theft and arson, empty commercial buildings are also a harbinger of a struggling economy.

 

In June, the delinquency rate for property loans bundled into commercial mortgage-backed securities (CMBS) hit a near all-time high of 10.3%, a jump from only 2.8% a year prior, according to “CMBS Delinquency Rate Surges for the Third Month; Nears All-Time High,” produced by Trepp, a CMBS data tracker. While hoping that most commercial borrowers have already requested relief, analysts expect the rate to continue increasing.

“The pandemic’s impact on the economy could harm insurers more on the asset side than in losses,” Mildenhall says. Low investment income has been a struggle for insurers since low interest rates were introduced by the Federal Reserve to spur recovery from the Great Recession about a decade ago. Before 2020 began, Marchitello observes, commercial lines, including property coverage, were suffering from “chronic subpar earnings over the past few years.”

Bond market returns, which most insurers rely upon for investment income, have “remained lackluster,” according to the Fitch Report. As a result, the industry has not been able to use its investments to offset bad underwriting results, pressuring carriers to adjust rates and coverages as needed to better ensure an underwriting profit.

Declines in commercial property value could also be a sign of future bad news. Since the beginning of COVID-19 lockdowns, values declined in March and April, depending on property type, from 5% to 25%, according to Green Street’s Commercial Property Price Index published in August. Transactions have been “quiet,” so values have not changed since, the company reports.

The industries with the most loan delinquencies are lodging and retail, according to Trepp. Mildenhall expects that as telecommuting, online shopping and less traveling become more prevalent, the need for office, retail and hotel space will likely decline. Just changing workspaces will make a difference. Morgan Stanley anticipates the working-from-home trend will triple by 2024, according to a post on Alpha-Sense.

Actuarial Considerations

Commercial property actuaries need to combine data from past experiences with new data sources to anticipate the potential of risk evolution, Bassi says. For example, changes in building codes, building materials and claims handling practices can all impact property risk.  “I see innovation as key for improving commercial property insurance,” he adds.

New technologies can help actuaries gain needed insight into underwriting and claims management. “The ability to remotely access damage post an event allows claims professionals to safely and quickly triage losses, especially in areas that are hard to access, and can help with the mitigation of losses post events,” he observes. Automatic water sensors and shutoff valves help proactively manage water damage risks. Bassi adds that evaluating the impact of these devices on claims costs can be an important part of an underwriting assessment.

Besides locating more data sources, actuaries can also benefit from working with other disciplines to see risk from different angles, Bassi says. “Engineers, CAT modelers, geoscientists, legal experts, and others all provide insights into developments that can impact risk quantification,” he adds.

Conclusion

Commercial property insurance was already experiencing an intense hard market before the advent of COVID-19, due to low investment returns and higher losses from weather events.

The steep economic recession that occurred as a result of the COVID-19 pandemic has made underwriting commercial property coverage even more challenging. The uncertainty of past and future liabilities, unsettling investment options and emerging sources of loss will likely mean customers will continue to face rising rates.

But hope remains. Commercial property insurers could start by encouraging risk mitigation and more clearly communicating coverage to their customers.


Annmarie Geddes Baribeau has been covering insurance and actuarial topics for nearly 30 years. Find her blog at www.insurancecommunicators.com.