COVER STORY, OCTOBER 2009

STAYING INSURED
What property managers need to know in order to protect vacant and partially vacant properties.
Daniel Larmore and Patrick Grace

One of the great misfortunes that arises from any significant economic slowdown is the way in which the secondary impacts of a recession frequently create an entirely new set of difficulties beyond simply a credit crunch and cash flow problem. These ripple effects move through the marketplace in sometimes unexpected ways. One of those secondary impacts is the troublesome issue of how to secure and maintain adequate insurance for the sudden glut of vacant commercial properties. Faced with an overabundance of vacant or partially occupied commercial space, owners and insurers alike are wrestling with how to structure policies; where to go to secure a new policy if an existing traditional policy no longer applies; and how best to make the kind of operational and financial changes necessary to mitigate the liabilities that are inherent to these buildings.

With the amount of vacancies in commercial properties escalating everyday, the need for sophisticated, flexible and effective commercial insurance policies is evolving. But what exactly do commercial real estate owners and managers need to be aware of, and what should they be looking for to make sure they are not at risk for liabilities with their properties? What can insurers do to mitigate some of these new risks and how can they work with their clients to minimize risk and improve their existing policy structure? Understanding risk exposures in today’s changing commercial real estate environment is the first step toward crafting policies that meet the needs of both the insured and the insurer during a challenging time, and toward preventing costly, avoidable and mutually unsatisfactory policy cancellations.

Vacant or Partially Occupied Guidelines

One of the core issues surrounding vacant or partially occupied commercial property insurance is a lack of available coverage options. Simply put, there are not many companies that want to insure a partially occupied building. While there are some insurers who specialize in insuring vacancies, the complexities and unique risk profile associated with the circumstances surrounding vacant or partially occupied buildings limit the available insurance options and in some cases make this niche product a cost prohibitive proposition. In many cases, the likelihood is that a traditional ISO-backed policy will simply not cover many of the buildings struggling with occupancy issues. It is extremely important to keep in mind the fact that all policies vary and the point at which a property is considered “partially occupied,” and therefore making an existing policy null and void, is critical.  There could be situations where an owner thinks its policy is still accurate and, when, in fact, it is no longer providing risk protection. 

For owners, operators and developers who are not able to avoid violating the vacancy guidelines in their existing policies, options can become dramatically limited. Securing a policy through the excess and surplus lines market, where coverage is likely to be more expensive and limited, is frequently the only viable way forward.

The emergence of a new and complex set of liabilities and exposures, combined with the need to trim budgets and reduce premiums, is not just a contradiction; it can be a non-starter for those who are not willing to adapt to new circumstances. Even in cases where a building may be experiencing partial vacancy, providers may identify new risks, and renewing an existing policy becomes a problem, or even an impossibility, with an existing carrier. The reluctance to insure, or the need to institute higher premiums or simply insure for less, can place tremendous new pressures on owners and operators who are already struggling. Those pressures can become particularly acute as a building approaches the contractually agreed-upon vacancy percentage at which a policy becomes null and void.

Among the biggest insurance problems posed by commercial vacancies are the new and potentially costly exposures that arise from a lack of consistent professional maintenance. Day-to-day funding for routine maintenance and upkeep is unfortunately often one of the first line-item casualties in the operational budget of a building that is vacant or lightly occupied. But the attempt to save a few dollars in the short term can often have a detrimental long-term impact on the insurance and risk profile of a property. Alarm systems may be left off or not well-maintained in a misguided attempt to save on electricity bills, increasing the risk of vandalism or theft. The increased risk of fire in vacant buildings is a tremendous concern for insurers, as sprinkler system maintenance and testing often falls by the wayside when occupancy drops.

The bottom line is that bad things happen to vacant buildings. From pipes breaking because of insufficient heating, to possible mold and mildew damage that spreads unobserved and unremedied due to a lack of occupancy or poor environmental controls, the risks inherent to unoccupied spaces are significant. A vacant or partially occupied property presents a number of tempting opportunities for cash-strapped owners and operators trying to cut corners, but cutting back can have serious consequences. Saving a little money by not salting an icy parking lot in the winter not only exposes owners to a possible slip-and-fall lawsuit, but also subsequently impacts the price and scope of insurance coverage they can reasonably obtain. The fees associated with proper maintenance can be a significantly easier burden to handle than the policy limitations, increased rates and premiums that will follow an accident claim and possible lawsuit.

Save Money Without Cutting Corners

In the current environment, many owners are strongly motivated to save money on their insurance policies. There are opportunities for insurers and owners to work together to save money and keep coverage in force in other ways - reducing insurance expenditures such as restructuring coverage, and re-examining priorities and exposures. Some exposures are unavoidable, and the character and attributes of the building itself can play a large role in determining how much leeway is available to insurers. A responsible insurance provider will always consider things like the adequacy of existing sprinkler and safety systems, as well as other less immediately obvious factors such as the nature of the tenants themselves (“Joe’s Metal Widgets” is understandably less likely to face high fire insurance premiums as would “John’s Wicker, Kerosene and Fireworks Emporium”). When determining an appropriate level of coverage for vacant or partially occupied properties, traditional commercial insurance considerations loom larger than ever. Providers will consider the context of surrounding buildings (clusters of vacant properties may present more of a crime risk), and other key elements such as the age of a building, when the plumbing was updated, the structural integrity of the roof, the electric infrastructure, and other basics.

For owners and operators facing significant vacancy problems, the  most important thing they can do is take the proactive step of carefully reading and fully understanding their existing policy, and keeping the lines of communication open with the agent and carrier about possible policy violations. Some owners may consider cutting rental rates to help bolster occupancy levels, and in some cases it may be possible to negotiate with the underwriter to navigate a temporary lull in occupancy. Steps such as hiring additional security and taking other safety and maintenance precautions may be enough to satisfy the insurer that risks to the property have not become too great, and coverage may continue on a modified or conditional basis. In almost all cases, however, these are temporary measures; the only true long-term solution is a change in policy or – more likely – improved occupancy levels.

Flexible insurers will also work with owners and operators who are dealing with increased vacancies and need to reduce their insurance expenditures by carefully analyzing not only their current policies, but their policy and liability history to find opportunities to save money. This is a situation where having an experienced and knowledgeable agent can prove extremely valuable. Now is not the time to simply renew the same policy you have carried for years. Working together, both the property owner or manager and the insurer can identify the best ways to handle changes in potential exposures. By taking a closer look at recent claims, it is often possible to identify a cost-saving solution by increasing the deductible on an element of coverage where the exposure is less pronounced. An agent can help the owner or operator to, in essence, “redistribute” their premiums and provide coverage where it is most needed, while reducing coverage in areas where the risk is less pronounced. The bottom line for owners in the current economic downturn is that when it comes to insuring their properties, the best way to save money is not just to understand where their problems are, but also to identify where they are not.

Follow the Green When Going Green

Vacant and partially occupied properties are sometimes a tempting target for renovation or remodeling, and the rapidly growing popularity and prevalence of green and sustainable construction and design is also an important factor to consider when developing insurance strategies that effectively meet these evolving needs. The influence of green and LEED-certified rebuilding and renovation is being felt throughout the industry, and some carriers are offering new insurance products to cover renovation and rebuilding expenses. While property insurance costs remain slightly higher to insure a green building, many owners are drawn to the potential long-term savings available to them through fewer health claims and health insurance benefits, higher employee and operational efficiencies and lower maintenance costs.

For any vacancy or property with lower than expected occupancy, the importance of a thorough examination of the current terms of a policy and the past history of claims is paramount. Selecting a provider who knows how to assess and understand these evolving issues and is able to provide a flexible array of products to best account for them is the key to adapting to increased vacancies. Owners and operators should avoid the common mistake of cutting back on safety, maintenance and upkeep expenses, and should work closely with their insurance carrier to examine existing policies to determine how exposures have changed. Going forward, those owners and insurers who are best able to evolve to the new exposures that crop up in a rapidly changing economic landscape will be those who are best positioned to operate from a position of strength when financial circumstances improve.

Daniel Larmore and Patrick Grace are executive vice presidents at Meadowbrook Insurance Agency, a division of Meadowbrook Insurance Group Inc. For further information, please visit www.meadowbrook.com.

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