New Days Require New Ways (Part Two)

This month’s blog is the second of two posts. We focus on what may be new ways of assessing traditional credit underwriting issues. Last month we covered the need for commercial lending institutions to ask the right questions of their clients as it relates to commercial coverage, policy provisions and any coverage limitations.  This month we look at what has probably been a relatively small concern or consideration. But it has the potential for significant change: Commercial Insurance.

From an underwriting perspective, insurance coverage for a lending institution’s collateral has not been a major consideration. We may be very meticulous in assuring that we have a current insurance endorsement on file. But, if you are like me, you rarely read the whole policy or much beyond the endorsements and policy expiration.

New Days Require New Ways

The May 26, 2020 death of George Floyd in police custody in Minneapolis, Minnesota sparked protests and riots across 140 U.S. cities. Matthew Palazola, an insurance analyst for Bloomberg News, estimated that damages from “civil unrest” may reach as high as $2 billion. Prior to this year, the previous record for civil unrest damages was in 1992. This was stemming from rioting in Los Angeles related to the acquittal of police officers in the Rodney King beating case. This reached $775 million ($1.4 billion in 2020 dollars) in damage.

Property Claims Services (PCS), a unit of Verisk Analytics, designated the riots in Minneapolis as a catastrophe. The threshold for a catastrophe designation is $25 million in insured losses and may be natural or man-made. For the first time ever, PCS has designated this civil disorder and those that followed in over 20 states as a multi-state catastrophe event.

Perspective

To put the $2 billion of estimated insured losses in perspective, property/casualty (P/C) industry losses in 2019 dropped 52% to $24.4 billion from $50.9 billion in 2018. Of the nearly 90 catastrophic events, all were natural events with severe thunderstorms topping the list at $27 billion (49 events). Tom Johansmeyer, head of PCS, states this in the Claims Journal.  “…In the U.S., there has been no precedent for a riot catastrophe like this.” Accordingly, commercial borrowers will likely see an impact on policy renewals. It may even persuade some insurers to exclude coverage for damage caused by riots.

Robert Fleming, Resident Managing Director, Commercial Risk Solutions for Aon in Milwaukee, Wisconsin discussed things. He indicated that most commercial insurance policies currently do not exclude actions arising out of riots or civil commotion. Unless, however, these acts may be deemed acts of terrorism. Accordingly, many of the losses associated with physical damage to property would likely be covered by commercial insurance. It could also be covered by auto or homeowner’s insurance. Businesses that are forced to suspend operations or limit hours may have coverage under business interruption provisions. Also, “civil authority provisions” may provide coverage for lost income and extra expenses. This is in the event that police or fire department’s bar access to a specific area.

Potential Commercial Coverage Policy Risks

A risk not commonly considered in the commercial coverage policy may be sub limits for payouts. This would be on such items as demolition. In a September 3, 2020 article by Jim Sams in the Claims Journal entitled “Owners Find Insurance Inadequate to Cover Demolition of Buildings Destroyed by Riots,” he noted that many commercial policies have sub limits of $25,000 to $50,000 for demolition. However, business owners in Minneapolis were finding that the cost of demolition and cleanup could be in the $200,000 to $300,000 range; in some cases greater than the value of the property.

It is difficult to know the totality of losses at this point. Industry experts, however, will be looking at potential changes to commercial insurance policies. In the past, commercial insurers have viewed riots as a local risk. They felt this could largely be controlled by building a geographically diverse book of businesses. However, the damage and payouts to major retailers will certainly call for some rethinking of this approach. According to Mr. Fleming, some insurers are considering riot and civil commotion sub limits. Also, exclusions on renewal policies particularly for areas determined to be “high risk.” In other cases, carriers no longer want to write policies in the market and/or are setting overall policy limits. In Minneapolis, nearly all business owners are seeing premium increases. In one case an owner indicated that their premium increased by 50% and another by 100%.

All of this points to the need for commercial lending institutions to ask the right questions of their clients as it relates to commercial coverage, policy provisions and any coverage limitations. I guess we cannot skip reading and understanding the entire policy. Truly new days are requiring new ways.

Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.