How High Will They Go?

June 1, 2021
By: Lisa Ann Murphy, Nicole R. Brown

Commercial property (casualty) insurance buyers, who have endured price hikes during the 2020 calendar will see their insurance rates continue to increase through the 2021 calendar year, with some seeing double-digit rate hikes per industry experts.  Besides the general insurance market drivers of increased weather catastrophes, the market has been plagued with the challenges posed by social and political unrest and the Covid-19 pandemic during the 2020 calendar year.  These challenges are contributing factors to increased property insurance pricing and stricter policy terms for the 2021 calendar year.  In fact, insurers have become stringent in their underwriting by restricting coverage and excluding risks that may have been covered in the past.  

Severe storms, flooding, tornadoes, hurricanes and tropical cyclones in 2020 have led to insured losses in the estimated aggregate of Twenty-Six Billion Dollars ($26,000,000,000.00) to Thirty Billion Dollars ($30,000,000,00.00).  The costliest catastrophic event occurring in 2020 being Hurricane Laura causing an approximate Ten Billion Dollars ($10,000,000,000.00) in insured losses.  As result of the voluminous amount of weather conditions creating extensive insured losses, certain specific weather conditions are being tied to their own deductibles. For instance, separate wind and hail deductibles are becoming increasingly common in commercial property insurance.  Although hurricanes, severe storms (inclusive of hail and high winds) and other related weather conditions have accounted for the majority of all insured losses, wildfires have also made a substantial contribution.  

While property damage resulting from rioting, civil commotion and vandalism has been generally covered by most commercial property insurance policies, some insurers are now introducing exclusions in response to the recent riots and protests that erupted across the United States.  These events occurring across the nation simultaneously have caused widespread insured damage as many businesses were vandalized, looted and set on fire.  Insurers could not have anticipated this sort of risk as something that would have transpired at one time.  Therefore, insurers did not account for such risk in their pricing. 

In addition to the overall increase in commercial property insurance premiums, insurers are requiring extensively higher deductibles or overall changes to the type of deductible being utilized.  The two most common deductibles are: (1) flat or straight deductibles that set a fixed dollar amount regardless of the amount of the loss, which are applicable for each occurrence; and (2) percentage deductibles that are determined based on either the amount of the loss or the insured property value.  A trend now being seen in response to the recent surge in climatic conditions over the course of the last several years is to apply a percentage deductible.  A percentage deductible is often utilized for perils that can cause catastrophic losses (i.e., earthquakes, hurricanes, tornados and hail and windstorms).  Two (2) frequent determining factors of whether a percentage deductible may be applicable are the location of the insured property and the specific peril causing the loss.  For instance, a percentage deductible is common for a hurricane related peril in states along the Gulf and Atlantic Coasts.  

If a percentage deductible is being utilized that is based on a percentage of the insured property value, then the percentage figure of the deductible relates to the value of the property and not the amount of the applicable claim.  In the case of the foregoing, if a deductible is set for a certain type of causality that is separate from an insured’s standard property deductible, this deductible will be typically in the range of 2% to 5% of the total property value.  If the value of the property goes up, so does the deductible.  Whether a percentage deductible based upon the value of the insured property is available will depend on the specific insurer’s underwriting criteria.  

Alternatively, if the set percentage amount of a percentage deductible is based upon the amount of the loss, generally the percentage ranges between 5% to 15% which is dependent upon (i) the location of the insured property, (ii) the type of casualty involved, and (iii) the amount already being paid in premiums.  

With the significant increase in commercial property insurance premiums, higher deductibles and utilization of percentage deductibles, a commercial property landlord must anticipate and address any potential exposure and seepage (i.e., inability to recover from tenants) that may result based upon the language contained within their leases.  

Leasing Considerations

Insurance estimates typically disclosed to a prospective tenant in a letter of intent (“LOI”) with respect to that prospective tenant’s contribution towards the landlord’s insurance costs are generally given on an estimated per square foot basis.  These estimates are frequently noted in an amount less than $1.00 per square foot as the amounts quoted are only for the premiums and fail to consider any sort of potential property insurance casualty which would trigger a percentage deductible or simply a high deductible.  The insurance estimates are based only on the amount of the actual premiums being paid by a landlord for the then applicable calendar year.  If the estimates noted within the LOI are specified within a lease document, then appropriate language must be included to indicate that dollar amounts are non-binding estimates that in no way diminishes the tenant’s actual payment obligation regardless of the tenant’s liability exceeding the estimated amounts.

If a percentage deductible is applied for a certain casualty occurring at a shopping center, then it may be an unwelcome surprise for a tenant leasing 25,000 square feet of floor area in a shopping center containing a total of 150,000 square feet of floor area, when a catastrophic event occurs causing nearly Ten Million Dollars ($10,000,000.00) worth of damage.  If the set percentage deductible is 10% of the damage of the respective casualty, then the tenant’s proportionate share of the would be One Hundred Sixty-Seven Thousand Dollars ($167,000.00).  Most tenants will not be budgeting an additional One Hundred Sixty-Seven Thousand ($167,000.00) (at an annualized rate per square foot of $6.68) towards insurance costs to which the tenant would be responsible. Despite the foregoing, a landlord must adequately protect itself within its lease document to avoid not being able to recover the expense associated with a percentage deductible.  

A landlord should caution its broker when providing insurance estimates in a LOI.  A broker should be instructed to not (i) cap a partial or full calendar years’ worth of operating costs / common area expenses (“Operating Costs”) (if insurance costs are included therein) or insurance costs (if billed separately); or (ii) otherwise agree to cap annual increases of Operating Costs (if insurance is included therein) or insurance costs (if billed separately) to a certain percentage.  The best practice to follow is to keep insurance costs separate and apart from Operating Costs.

In the event insurance costs cannot be separated from the overall category of Operating Costs and an annual increase percentage should be agreed to by a landlord, the annual increase percentage should not apply to specific items of Operating Costs for which the costs are beyond the landlord’s control (i.e., insurance costs, utilities, real estate taxes, snow/ice removal and so on).  These uncontrollable expenses should never be subject to an annual cap of any kind.  Otherwise, the landlord will experience seepage and not be able to recover the full amount of the expenses actually incurred.  

When drafting the insurance recovery provisions in a lease for the landlord’s property insurance costs, a landlord should not limit the language describing the type of insurance costs to “insurance premiums”.  The usage of the foregoing limited description will arguably exclude the costs associated with any applicable deductible.  Broad and general language should be employed when describing the landlord’s insurance costs, such as the following: “Landlord’s Insurance” shall mean all costs incurred by Landlord in connection with the insurance maintained by Landlord.  The broad encompassing language will address any outside costs beyond the insurance premiums and allow for the recovery of any associated deductible.  Alternatively, to avoid any potential arguments being made by a tenant, a landlord may want to consider stating in the applicable lease that “Landlord’s Insurance” means all insurance costs, including deductibles, incurred by Landlord.  Of course, this will signal to a tenant that it will have an obligation to contribute towards any deductible in the event of a casualty, and may prompt a tenant to seek exclusions.  

In addition, regardless of the language used, savvy tenants may endeavor to exclude certain components of the landlord’s property insurance costs from the tenant’s contribution obligations.  These such tenants may seek to exclude deductibles all-together or exclude specific insurance coverage (whether as a separate policy or as an endorsement) for certain perils.  If a lease indicates that a tenant has no obligation to contribute towards earthquake insurance coverage, then it is likely that this tenant would have no obligation to partake in the cost of a deductible applied to a casualty resulting from an earthquake.  Likewise, a carve-out of a specific catastrophic event such as a hurricane, tornado or wildfire would lead to the same result.  Some tenants will attempt to cap the dollar amount of any insurance related deductible towards which the tenant would contribute.  Lease drafters need to pay particular attention to the types of exclusions that a tenant seeks to incorporate within the lease document.  Failure to account for these exclusions will likely expose the landlord to unexpected and undesired seepage. 

Unfortunately, a commercial landlord should expect to see its commercial property insurance premiums continue to increase over the years to come with continued restrictive underwriting by the insurers and changes to nature of the deductibles applied.  


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