Surviving the property meltdown

Another day, another depressing headline on the state of the UK property market. Every new set of data only confirms what many had been predicting – and an equal number trying to play down – since the US sub-prime crisis brought the London stock market to its knees last August.

In the first quarter of this year, the Royal Institution of Chartered Surveyors said demand for commercial property had fallen at the fastest rate for more than six years, to its lowest level in eight years. And there was worse to come. Demand for new offices dropped by a third as confidence in retail property dropped to the lowest level on record. Declines in rents are expected to double in some sectors in the next quarter.

But it’s not all doom and gloom. As Julia Abrams, director of account management for property investors at RSA, points out: “One person’s crash is another’s opportunity. Some investors are struggling but others are waiting in the wings with cash to move in at the right point.”

The same goes for insurers. Against all the odds, the market for property-related insurance has stubbornly refused to harden in recent years, so the downturn offers some hope of an end to unsustainable rates. But not yet.

“At the moment, the market still seems to be quite soft,” says Bill Gloyn, chairman of real estate at Aon and president of the City Property Association. “Everything says it should be hardening already, but it’s not. Around the world it is, but not in the UK. The claims don’t get any smaller and the numbers don’t get any smaller either.”

Last summer’s widespread flooding hit insurers with more than £3bn worth of claims, a blow the industry is still reeling from, as recent results have shown. While everyone admits the current rates are unsustainable, it seems property is still too attractive a market to reverse the supply-demand relationship.

“Property is seen as a very good performing sector,” says Mike Colmans, underwriting manager at Norwich Union. “It tends to perform better when other sectors maybe aren’t, and enables insurers to delve into other areas.”

Abrams agrees: “This sector has always been seen as profitable. But the commercial property market has gone through a period of very large losses with three or four years of rising claims costs and premiums are unsustainable. The general opinion is that prices have to rise.”

Blanket cover

Almost all the main players offer some property-related insurance – one reason why the market is so soft. Property owners tend to buy a blanket policy for their entire portfolio, which is then amended as they add or dispose of assets. It will cover standard damage through perils such as fire, flood or earthquake and protect rental income. They also have liability insurance in the event of a tenant tripping up and sustaining an injury as a result of the landlord’s poor maintenance. The executives may have directors’ and officers’ cover to protect them from the wrath of shareholders in the event of a bad decision. There’s also cover for the legal expenses of evicting squatters from residential properties, and engineering cover for the lifts and escalators in a shopping centre.

As the credit crunch puts new building projects on hold, there will clearly be less call ‘ ‘ for construction risks insurance. For other property-related products, the impact will be more indirect but no less significant. Buildings will have some degree of insurance whoever owns them, though the owners may cut back on the sums insured, which reduces insurers’ income.

“The amount of property in the UK is still the same, it’s still there to be insured,” says Mike Phillips, head of specialist markets at AXA. But he also points out that as companies go into liquidation the pool of potential tenants for commercial buildings is reduced. As the occupiers would usually be paying the premiums, empty buildings mean a double strain on property clients deprived of rental income and footing the bills for cover themselves.

At Biba, head of technical services Peter Staddon points out that higher fuel and materials prices coupled with the inflationary pressure on living costs and higher interest rates combine to deal a heavy blow to all sorts of companies. “The credit crunch bites in little bits, but when you put it on business and add it up it has quite an effect. Something has to give – normally insurance is one of those things.”

The tougher property market is also likely to mean fewer companies are around to buy cover. “The property investor market could shrink, or that market might turn to invest outside of the UK,” says Graham White, Zurich’s head of property and strategic exposure. He has noticed that property investors are looking across Europe for higher returns, particularly in Germany, Scandinavia and the East European countries, and even Russia. “We are beginning to see current customers changing their portfolio investment strategies, and offloading parts of their portfolios. And we’re beginning to see fewer new portfolios coming on to the scene in the UK.”

A common misconception about property insurance is that the sum insured relates to the value of a property. In fact, it only need cover the cost of rebuilding, which may be considerably less because it doesn’t include the cost of land. Alternatively, for listed properties or mid-terrace houses it may be quite a bit more.

Even if property owners do understand what they’re insuring, they may still use the property’s value as a benchmark. In any case, with the cost of construction materials and labour fluctuating, often increasingly wildly, there’s a greater risk that owners may be underinsured.

Accurate valuations

At Norwich Union, Mike Colmans argues that in a tougher market, it’s more important than ever for investors to get it right. “If they had a situation where they needed to raise some cash, they might buy or sell a property or get some finance. But with the credit crunch there’s a lack of buyers and sellers, and also the difficulty of getting access to lenders. We will pay only the amount insured, so property owners must make sure they are insured for the right amount, because where else are they going to get the money for repairs?”

As a direct response to the credit crunch, nine months ago Norwich Union launched a valuation service to make sure clients are insured for the right amount. Colmans says: “There shouldn’t be any reason to go for smaller sums here. In the vast majority of cases the tenant is paying the insurance cost. In other areas where people are paying it out of their own pocket, people think if I slightly underinsure, I’ll save money. But it doesn’t work like that with property owners.”

There is also a risk that cash-strapped owners will try to save money by cutting back on upkeep, with a resulting rise in damage or liability claims from poorly maintained buildings. Insurers should also expect a rise in that other recession favourite: fraud. The links between arson and an economic downturn are well known to insurers, as Zurich’s White explains: “There could be people whose business is not doing well and they decide the only way out is to raze their buildings to the ground. Or it could be because you’ve got more people on the dole kicking their heels in the poorer parts of society. There has always been a connection between arson and a downturn.” Zurich has already detected a slight increase.

Norwich Union is launching another new service that it hopes will cut claims on both. “We’re trying to help landlords to manage unoccupied buildings,” explains Colmans. “We have a management company that will go round to make sure buildings are locked up and that the gas or electricity isn’t left on. It gives you more confidence in the property owners if they’re prepared to take out an added-value deal like that – you know they care about their buildings.”

Too much capacity

With a dwindling client base with less money, it’s not looking good for a hardening market for property-related insurance. “We have a market that is extremely soft, but if there’s less business to pick up, that would suggest that it will continue to soften,” say White. “Despite all the things thrown at it like last year’s flood losses, it doesn’t seem to have the appetite to harden. There’s still too much capacity.”

Norwich Union, AXA and Groupama all say they’ve been trying to raise rates for commercial property products with some success. “We’ve hit the bottom of the cycle and what should be acceptable to us,” says Philip Bird, director of non-motor and SME at Groupama. “There’s a real need to push prices up. We are trying to do that at the moment on commercial property and commercial liability, but it’s not always possible to sustain. We’re seeing some improvement on renewals and we’re trying to do the same with new business. But with lots of insurers battling for premiums, I don’t think the rating environment looks good this year either.” He’s crossing his fingers for 2009.

At Deloitte, insurance partner Ian Clark puts it even more bleakly: “At the moment, there’s too much capital chasing too little premium. It won’t harden until there’s a catastrophe of some magnitude in the US.”

Even if 2009 does bring a much-needed hardening of the market, it may be the silver lining to a very black cloud.