The Coming Storm

In late November, an insurance renewal policy for a Manhattan cooperative rested on insurance broker Robert E. Mackoul's desk. The figure on it was $80,000. As president of Mackoul & Associates, he had seen rates go up before. But he had not seen anything quite like this.

"The building renewed for $26,000 two years ago," he recalls. "Last year, it was $40,000. This year, it was $80,000. No one knows where this is going. I have another building on 40th Street that wanted to shop insurance around. In August, they found two other insurance companies with similar rates to what they had, but with more coverage. By November, the two companies had more than doubled, while their current holder hadn't put in for any increases." .

The news about insurance and co-ops is not good. Still reeling from the September 11 terrorist attack on the World Trade Center, insurance carriers are hurting. Some industry experts say that when the cards finally fall sometime between now and April, a few boards could be looking at increases in their premiums as high as 300 percent.

Before the attack, boards were, for the most part, aware that insurance prices would be increasing, on average, by 30, not 300, percent. Across the spectrum, there was a trend toward a 10 to 20 percent increase in premiums. Agents say that the price war in the industry during the previous 10 to 15 years had finally abated enough to let companies begin trying to increase their rates. However, with the attacks, which have caused about $38 billion in losses to insurance and re-insurance companies, insurance premiums are now expected to increase anywhere from 15 to 40 or 50 percent. (The $38 billion in losses are split roughly at 40 percent to the insurers and 60 percent to the re-insurers.)

"The attack just escalated the increases dramatically," notes Alex Seaman, senior vice president of Kaye Insurance Associates. "Boards should be budgeting for increases of 20 to 50 percent, unless they are aware of poor loss experiences at their building, in which case the rates could be even higher."

The potential rate increases sound scary, but the truth is even more unnerving: nobody really knows what's going to happen. Here's why: let's say a building is insured for $40 million. An insurance company is only going to cover a portion of that with a re-insurance company picking up the rest. An important point to remember is that re-insurance companies, unlike insurers, are not regulated by the state. After the attack, most re-insurers said that, come January, they would exclude acts of terrorism from the coverage. With some 70 percent of re-insurance treaties renewing this year, most buildings will be affected. The responsibility thus falls on the insurance company to cover the piece just given up by the re-insurer. At this point, the insurance companies are prohibited by the state from creating a terrorist exclusion. Therefore, they are responsible for that piece of the pie.

Would rates be lower if they were able to exclude? Maybe, but that would also create a host of new problems. According to Seaman, the most serious would be that banks would not want to lend money to properties that might not be able to rebuild should they be destroyed. "If the bank's going to lend $100 million to a property and it has a terrorist exclusion then funding is going to dry up," he says. In addition, it may jeopardize loans already in existence, creating the potential of banks foreclosing on outstanding loans.

However, since the exemption is not currently allowed, the cost has to be picked up somehow. As yet, no one is sure what that price tag will be. Towards the end of 2001, most insurance companies were having enormous problems getting quotes from re-insurance companies. This, in turn, created difficulties in carriers producing quotes, which left brokers unable to say what the direct costs would be to boards. The worst-case scenario is to have hundreds or thousands of customers looking at the last minute for alternative quotes, which, according to Seaman, would further tighten the market and increase rates even more.

The bottom line is that an insurance company isn't likely to take such a large risk without compensation. The result is an increase in premiums and probably a decrease in coverage. For instance, one of Mackoul's properties was insured for $40 million last year but could renew for only $10 million this year.

Boards may see other changes that will affect how much they pay. The way a property is rated and also classified can be changed, thus allowing for higher rates. Many insurance companies provide credits for good customers. These discounts can be reduced or even eliminated. Customers are also classified on a tier scale: "super-preferred," "preferred," or "standard." These classifications, based on the age and condition of the building, can also be altered.

Finally, changes in the "insuring to value" standard have already occurred. This is the cost of replacing the building. Barbara Strauss, senior vice president of York International Agency, notes that many insurers are finding the old calculations unacceptable. "We're entering a hard market. Insurers now want to do $200 a square foot for office, $150 a square foot for fire-resistant co-ops and condos and $100 a square foot for brick co-ops. These are all increases over the previous pricing. I wouldn't want to be the person on the board, though, that says that we don't need that much. This is the way it is going to be for a while. You can't paint a rosy picture."

"There is a pretty terrible situation developing and it is not being recognized or understood as it should," agrees Warren Heck, chairman and CEO of Greater New York Insurance Companies, the largest writer of co-op coverage in New York City. Among its portfolio are 160 buildings south of Chambers Street. Heck has seen "catastrophe" coverage go up tremendously, as well as "clash" coverage for casualty. The increases boards are likely to see, he says, are largely the result of companies trying to pass on their expenses, not to make a huge profit.

That's not to say those issues aren't out there. One interesting development is that the property/casualty insurance and reinsurance industry has been successful in raising money from investors. Since these companies may now be in the position of increasing rates on many lines of business, it is being seen to some as a good investment. Anywhere from seven to a dozen new insurance or re-insurance companies have formed or are expected to form. Between $10 billion to $20 billion of new capital will flow into the insurance market over the next few months. The bulk of this will go into the re-insurance industry, Standard & Poor's reported in November.

What does this mean to boards? "When it comes to a choice between two carriers with similar pricing, the highly rated company (the one that has been in the industry longer) will be favored because that insurer provides a more stable source of capacity," notes Donald Watson, a director of Standard & Poor's Financial Services Ratings. "The result is that start-ups will have to discount business to lure the customer away." How much that discount will be remains to be seen.

The other side of this coin is the possibility that insurance companies could go out of business. After Hurricane Andrew tallied up $15 billion in losses in 1992, six American insurance companies went bankrupt. Some estimates on the total damage caused by the attack are as high as $60 billion. Again, no one is quite sure what will happen.

Solutions to the larger problems, such as what to do about terrorist exclusions, have yet to materialize. One possibility that Heck has looked into is stand-alone terrorist coverage, but that can be very, very expensive, he notes. He has yet to have any buildings decide to do this.

This is a time where it actually pays to be a small building, says Mackoul. While the increases are sure to come, they are not likely to seem as big as they are for larger buildings. "If the premium for a smaller building goes up 15 or 20 percent, say from $6,000 to $7,500 it doesn't look as bad as [it does] for a building that's going up tens of thousands of dollars. Some companies that cover smaller buildings are also making more modest increases." If you are one of the lucky buildings to get hit with only a 15 percent increase, says Mackoul, "get on your knees and thank God."

The most probable solution to this crisis, say experts, is that the government will get involved as an additional insurer, picking up that piece that the re-insurers are dropping. Just as the Federal Deposit Insurance Corporation protects banks, this fund would aid insurers in the event of another tragedy like the World Trade Center. The last proposal before Congress had the insurance industry sustaining the first billion dollars and then the government sustaining up to 90 percent of any additional losses, up to around $20 billion.

"The only answer is the government," asserts Heck, who is a member of the National Association of Mutual Insurance Companies and the New York Insurance Association, both of which are lobbying for aid. "So far, they haven't given an acceptable response and there is not a lot of time left. The problem with terrorism is that the losses are unlimited. If the government will set a deductible then you get a finite amount. The industry will still have to sustain losses but we can't afford another loss like this. Eventually there will be a solution. There's no choice. It's a desperate situation."