Soaring Insurance Costs: When Will Investors Find Relief?

Since 2016, the CRE insurance market has faced turbulence due to natural disasters and rising capital costs. This week's episode with Ted Brown, President and Partner at Lockton Companies, breaks down the impact of skyrocketing insurance rates on deals. Ted explains how underwriters initially priced for low catastrophe risk, but consecutive severe weather events led to increased rates. However, there is a silver lining! Tune in to find out when he believes rates will stabilize.

Transcript

Rachel Oh 0:04

Welcome to Peaks and Portfolios presented by Peck Companies, your go-to podcast for all things commercial real estate investment. I'm Rachel oh, and together we're diving into current events, trends, issues and opportunities impacting the CRE investment space, from dissecting the latest market moves to sharing insights on today's commercial real estate landscape. It's time to maximize portfolios here in the peaks of the Mountain West and beyond. Okay, welcome everybody. Thank you for joining us today. We're so excited about this week's episode, primarily because I actually have my guest in the room with me, which I never do. So welcome, ted. Thank you so much for joining us.

Rachel Oh 0:47

All the way from the big state of Colorado. We've invited Ted today because one of the things that we're finding in real estate as we do our underwriting, is the cost of insurance and how it's impacting our investments. Soaring insurance rates are killing deals, if you will. In real estate, and if you look at the past decade, the average insurance costs have actually doubled over the past year, so that spike has slowed down sales. It's impacting the way we underwrite and I imagine many of our listeners are also experiencing this and you know, at PEG. It's impacting the way we look at different states. For example, we're pretty heavy in Texas and Florida, so I know you're going to talk about that a little bit more, but that has impacted the way we look at those states, and so we wanted to dive into the insurance space today, and you were so gracious enough to join us. We're super excited to have Ted Brown. So Ted Brown is the president and partner at Lockton Companies, and where is Lockton based?

Ted Brown 1:46

So Lockton's, based in Kansas City.

Rachel Oh 1:48

Okay, yeah.

Ted Brown 1:49

And I'm president of the West Series of Lockton, so pretty much everything west of Denver.

Rachel Oh 1:56

Oh, okay, awesome, yeah, no, I saw that in your bio and it looks like during your tenure and your role, the company's significantly grown. Yes, and they attribute, at least in the bio, much of that to you. So congratulations on your success, and Lockton is super lucky to have you.

Ted Brown 2:11

Thank you. I'm lucky to be here. It's been a fabulous organization. They've supported me every step of the way, yeah.

Rachel Oh 2:18

I'll admit, when I think of insurance it's kind of like ho-hum, boring, boom, you know State Farm, little sign. But you are kind of a cowboy, kind of a southern kid. Tell me a little bit about how you got into insurance in the first place and how it's morphed into what you do today.

Ted Brown 2:34

Yeah, no good question. Yeah, I don't think there's not a whole lot of people that when they're growing up say, I really want to go into insurance.

Ted Brown 2:43

Yeah, but yeah, I was working in the outdoor industry before Lockton and ran a small part of WL Gore Gore-Tex Fabrics, and I wanted to get back to Colorado and my wife and I were excited to do that. I was actually looking to go into commercial real estate and had asked for some introductions from some folks I knew at Lockton and they said, well, why don't you come talk to us? And I said I don't want to sell insurance. That sounds horrible. And I learned a lot about the company in particular, but also the industry and how complicated it is and it's a global financial marketplace just like other financial marketplaces, and pretty blown away at how dynamic it is and so it's. Yeah, it's been almost 18 years since I've been there.

Rachel Oh 3:30

Wow, you grew up at. Lockton Pretty much. Yeah yeah, that's amazing. You know again a super impressive background. I think something that might be helpful to our listeners too is that we just recently partnered up with Lockton, so you folks are our insurance partner, and from what I hear, that might be helpful to our listeners too is that we just recently partnered up with Lockton, so you folks are our insurance partner, and from what I hear, that should be super accretive to the company as well as our investments, so we're super excited.

Ted Brown 3:54

If I do my job, it will be.

Rachel Oh 3:55

Yeah, yeah. So, as we jump into this today, the two main areas of insurance that we're going to be covering is liability versus property. Do I have that right, ted?

Ted Brown 4:04

Yeah, the difference is property is going to be property, it's, you know, anything that can burn down or experience, you know, physical damage associated with, you know, with natural catastrophe, fire, water leakage, etc. Liability is going to be either construction defect or it's, you know, on the development side, or it's going to be slip strips and falls at property level. So residents that are suing property owners those types of losses.

Rachel Oh 4:35

So so let's start with property. It sounds like there's some good news today.

Ted Brown 4:40

There is some good news. Things are headed in the right direction.

Rachel Oh 4:43

No, I really love that. So let's, let's kind of segue then into that today. Like again, my experience with insurance is quite limited, just as a you know, your typical auto, home life, whatnot. But then of course, in my role here at PEG, I am starting to see the impacts that insurance. I mean insurance just seems to be a little tiny line item, and now that has significantly grown. Seems to be a little tiny line item, and now that is significantly grown, and I'm now starting to hear the analysts kind of, you know, pause and talk about well, now it's doubled here or tripled here and that's impacting this and cause. You know we'll be like well, why are the distributions lower than they used to be? Well, it's because the insurance dah, dah, dah. And again, I'm talking primarily like Texas and Florida, but I'd love for you to maybe just give us a primer on the overall insurance market today, like how does it work and how does it specifically impact real estate?

Ted Brown 5:29

Yeah, I appreciate that and I think I'll talk a little bit about where we are in the market cycle. Yeah, and it is a cycle.

Rachel Oh 5:35

Yeah, so you know, for listeners, it's not forever, this will change and it's already yeah, there's already good news in the market right now, but it is cyclical.

Ted Brown 5:45

It's driven by equity, just like the real estate industry is, and so if you look at kind of the anatomy of a market cycle, what happens is profitability is impacted and that results in a constriction of capacity and loss-prone industries, like a lot of real estate asset classes. You see a restriction in capacity.

Rachel Oh 6:05

What do you mean by restriction in capacity?

Insurance Trends Impacting Real Estate

Ted Brown 6:07

It starts really with the reinsurance marketplace. So if you look at, kind of, the bottom of the market was about 2016, 2017, that we hadn't had a natural disaster for about five years prior to that and rates really cascaded down. Underwriters were pricing for catastrophes that weren't really happening.

Ted Brown 6:29

And so they were really just pricing for a fire risk for the most part. And then we started to have year after year after year of natural disasters and over that five-year period you had a whole lot more rooftops going in, getting built in cat-prone areas, yeah, but then also severe weather events that are outside of just hurricanes, so you had, you know, a lot of hail exposure, start to crank up, convective storms, a wind, tornado.

Rachel Oh 6:58

We had a hail storm just two weeks ago.

Ted Brown 7:00

It's a big one, I mean in the middle of nowhere. Yeah, okay, yeah.

Rachel Oh 7:06

So Mother Nature is basically driving up insurance, is what you're saying.

Ted Brown 7:08

Well, for property that's a big factor in all of it. And liability we can talk about in a minute. But the property marketplace, when we started to have all those losses, the property carriers were trying to catch up those losses. The property carriers were trying to catch up and you had a number of severe weather events to where the reinsurance marketplace was affected and reinsurance affects the cost of capital for all the commercial carriers. So you know commercial carriers just like PEG does you know they insure. So you know they'll have an attachment point.

Ted Brown 7:44

you know on their book of business that they'll buy insurance for and so when the reinsurance market is affected then the cost of capital goes up for the commercial carriers. So year after year of those events and again going back to capital and equity, if you look at the S&P during that time, the average return is over the last seven years probably 13.5%, 14%. Sure Insurance has been about 7% return on equity during that time. And so until carriers have been able to get to a certain level of profitability, to where their return on equity is creeping up towards 10, 12 percent, you don't see a turn in the marketplace. So over the last couple of years, that's why rates have continued to go up and capacity for specifically multifamily or wood frame construction you know that really lags the market that constricted, so it was a supply and demand issue.

Ted Brown 8:47

You had a ton of demand and not as much supply, and so the pricing continued to go up. And now the carriers on the property side have finally gotten to a point where they're making a profit, got it? So that's when you start to see the tipping point in the market, which this was the longest hard market, I think.

Rachel Oh 9:09

So basically you're saying from 2015 to now.

Ted Brown 9:12

About 2016, 2017.

Rachel Oh 9:14

2016 to now is where it's just been.

Ted Brown 9:16

Been going up every year.

Rachel Oh 9:17

Wow.

Ted Brown 9:18

Yeah, and so that tipping point. We've all been waiting anxiously for that, as brokers for sure that's starting to come. So last year, without a major hurricane, it was still a $130 billion loss year, mostly due to natural events. So hail, tornado, flood, those types of events and the carriers were still able to be profitable.

Ted Brown 9:49

So they've gotten to a level of durability where they can absorb that loss and still make money, and so they're hovering at profitability levels that are encouraging and we're starting to see on the property side, rates come down. So reinsurance again affects cost capital for the carriers. You have a big reinsurance treaty renewal around the first of the year. Those were very favorable.

Ted Brown 10:17

So the carriers if you look back 12 months prior the reason why we saw another huge jump in rates in 2023 was just because of reinsurance. It wasn't necessarily because of all the underlying factors. It was because they were getting to a point of profitability. Then Ian hit and the reinsurance market was hammered and so they had to pass on those increases. Those get passed on the commercial carriers, then they get passed on to you all Right. And we have to deliver that bad news.

Ted Brown 10:50

So 2024 should be good news then 2024, yeah, we're starting to see rates level off and starting to see carriers open up capacity more, more in catastrophic areas, write more loss-prone asset classes like multifamily or wood frame hospitality, and that's, you know, a sign that you know their appetite's growing and they're going to grow their profitability through volume, not necessarily through you know the management of expense.

Ted Brown 11:24

So they're looking to expand that capacity and grow. I was in London two weeks ago and you know the underwriters there. Very stark difference from even six months prior when I was there. They're more aggressive, they want to write more real estate business and so it's all. It's all positive. I think we've, you know we're we're seeing a good trend there.

Rachel Oh 11:50

The liability marketplace is where property was about 12 to 18 months ago okay, so they're lagging, then it's going to take them a minute to catch up exactly and the liability marketplace is.

Ted Brown 12:05

It's not driven by natural disasters, it's driven by you know the tort environment and you know certain jurisdictions, and so would California. California is one, Atlanta is a tough one. States like Texas and Florida can be pretty tough from a mass tort perspective, and that's what's driving a lot of this is that you have, for the first time in history, private equity is funding mass tort.

Ted Brown 12:32

It's, you know, a several hundred billion dollar industry at this point, and so you have a lot of capital going to plaintiff's attorneys and funding mass litigation, mass lawsuits and mass tort.

Rachel Oh 12:46

I'm sorry, private equity is funding torts in the US.

Ted Brown 12:50

Yeah, that's a very profitable industry.

Rachel Oh 12:53

Yes, I guess I just wasn't aware. Interesting, okay, so they're incentivized to drum up these lawsuits just everywhere because they've got capital funding behind them.

Ted Brown 13:04

In certain jurisdictions.

Rachel Oh 13:05

That's where a lot of that money is funneled OK so it's not just the random lady that gets scorched by a McDonald's coffee cup.

Ted Brown 13:14

No, it's not. But, there's more and more.

Rachel Oh 13:18

So it's much more complicated. Obviously it's much more.

Ted Brown 13:21

It is. I think there's other factors as well, social inflation being one of them. Yeah, the cost of health care, the cost of defense.

Rachel Oh 13:27

I was going to say it's got to be health care, it's got to be a big piece of it, and then, I'm sorry, you said defense, yeah. Cost of defense yeah, okay.

Ted Brown 13:34

So obviously you know going up no-transcript.

Ted Brown 13:54

Yeah, and so those are all coming through the system. Now You're seeing those claims go through the roof. And so you know, with liability, you know you have primary, then you have, you know, umbrella, you have access, et cetera. Well, umbrella and excess coverage was really just there for catastrophic stuff, but over the last 10 years it keeps. You know these, because of the tort environment, because of social inflation, these run-of-the-mill cases are settling for much higher dollar amounts than they have historically and it's penetrating into those umbrella and excess layers. Those layers then become working layers.

Ted Brown 14:36

They're not just there for catastrophic cases and claims, and so they've had to try and catch up to that market as well. And you see the restriction of capacity, yeah, and you see the supply-demand curve change and there's a ton of demand and not enough supply, so pricing goes up.

Rachel Oh 14:55

Okay. And until they find a way to be profitable short of tort reform carriers are going to have to— I was going to say, unless you change that like, it seems like it'll always be. Whereas natural disasters may ebb and flow and costs may ebb and flow, but does tort cases ebb and flow? I?

Ted Brown 15:12

guess you could say they could based upon local elections.

Rachel Oh 15:17

Oh, true, true, true true.

Ted Brown 15:18

But right now, you know it's not a red or blue state issue. Well, you know it's not a red or blue state issue. Some of the red estates are really tough from a tort perspective and litigation perspective, and same with some blue states, and so it's really you can drill down to certain cities, certain jurisdictions that are— they just have a history of tort. Yeah, they're really tough, and the plaintiff's bars in those jurisdictions do a great job. You know pushing for massive settlements, and so they get them.

Rachel Oh 15:53

Wow, okay, wow, I just learned a ton. I had no idea. Okay, so then you have liability on one end. You've got the property on the other end, the property is starting to ease up, which is obviously, you know, happiness to my ears. Tell me then, you know, let's talk a little bit about. Just when I look at, my readership is typically, you know, investors that are similar to us. Tell me a little bit about, like, how does it work, state by state across the union.

Ted Brown 16:20

You have to look at it through a couple of different lenses across the union. You have to look at it through a couple of different lenses. One is you have to break it down by asset class and construction type from a property perspective. So if you think about what's going to lag the market from a construction type, it's going to be wood frame, because it burns down and can blow over.

Ted Brown 16:40

And so if you overlay wood frame, whether that's hospitality, whether that's multifamily, and you put that in, you know, gulf Coast, texas or in Florida, that's going to be what lags the market. When the market's correcting, that's still going to be. You know, those are the construction types that are going to have a hard time catching up to the market. If you have noncombustible construction, so masonry, non-combustible concrete steel.

Rachel Oh 17:06

Which is super expensive, by the way.

Ted Brown 17:08

Super expensive.

Rachel Oh 17:09

That's right?

Ted Brown 17:10

Well, but with the cost of insurance. That's something that real estate owners, investors, need to think about is okay, while wood frame may be less expensive to build, while wood frame may be less expensive to build. What's the cost of that over a seven-year hold period compared to? The cost of like-edge steel or concrete.

Insurance Premium Impact Across US

Rachel Oh 17:33

Okay. So, Ted, as we look across the US right now, what are the key states that are driving costs in insurance premiums right now?

Ted Brown 17:42

Yeah, there's a number of different factors. You have factors affecting liability that could be state-specific, jurisdictionally driven. Then you have property and that can be driven by weather events, natural catastrophes, crime, etc. So, going back to your question, what are the states that are driving this? You know Florida's tough, it's changing. We're, you know, getting better.

Rachel Oh 18:06

And I feel like Florida has a lot to do with floods, right. Isn't that a big piece of it.

Ted Brown 18:10

Yeah, when you have a hurricane, you know wind is a big issue. But storm surge, flood, you know that's what is kind of you know the thing that sticks around the longest and really causes a lot more damage. So you can have, you know great construction type. That is just fine, you know, from a wind perspective.

Ted Brown 18:33

But then you know you have an entire parking garage get flooded and you know their HVAC goes out or you know, whatever that might be, and so I think you know a lot of real estate developers are getting smarter about how they build in cap-prone areas and they're doing a lot to mitigate loss.

Ted Brown 18:51

But you know, the Gulf Coast, texas and Florida. Certain parts of Florida, not all of it, although it gets a bad rap. There's certain parts that you know are a little bit safer than others. You know those are tough states. You go up the Atlantic Coast, south Carolina, in parts of North Carolina, up into Virginia. That can be kind of tough. But the entire state of Texas is really the toughest from a natural catastrophe standpoint, or not just from a weather event standpoint, because if you look at like the DFW Metroplex for example, you know there's something like 20,000 units that are getting delivered there over the next you know I can't remember what it is.

Ted Brown 19:32

12 to 18 months and that's a lot more rooftops, and you have historic freezes happening and we're staring at you know the predictions are this is going to be one of the most active hurricane seasons we've had. But again, good news in the market. According to a lot of underwriters, they can sustain a couple of major events and still be profitable.

Rachel Oh 19:58

And still be profitable. Interesting Because they've charged us that much in premiums. Correct To offset. Yes, interesting.

Ted Brown 20:05

Again, it's a cycle.

Rachel Oh 20:07

It is.

Ted Brown 20:09

Just like real estate. You know there's a cycle. I mean we're in a development cycle right now. Yeah, it's not exactly favorable. That'll come back around.

Rachel Oh 20:17

So it sounds like, then, from what you're saying, it's brisk building activity, along with weather. Those are the only two things you've really mentioned. Anything else that impacts what makes?

Ted Brown 20:28

like for example.

Rachel Oh 20:29

You know I'm living here in Salt Lake City.

Ted Brown 20:31

One of the safest places. We have nothing going on.

Rachel Oh 20:33

I mean knock on wood, although right now they are earthquake proofing. You know all the temples and whatnot, and so I think if you are a believer, like God must know something we don't know. But my point is and then I grew up in Seattle and I don't feel like anything- happened there either.

Ted Brown 20:54

So are those. So you're saying like a state, like a Utah is just yeah, A state like Utah, I mean you take a earthquake out of it.

Rachel Oh 20:57

It's, it's very, because we're on a fault technically, but I mean, nothing's well, we had that tiny little one during COVID randomly. Yeah, you all did that's right. Yeah, like a tiny little. Yeah, yeah, it was like a 2.3 or something like that.

Ted Brown 21:11

Something little yeah weirdly, and that's, you know like. The bigger concern is when does the next big quake come?

Rachel Oh 21:19

Sure.

Ted Brown 21:20

And so you know the good thing about development that's been going on is a lot of that is pretty durable construction from a quake perspective, you know, and that's being driven by equity investors, that's being driven by lenders. That's you know. If you're developing that's, you know they're going to want to see. You know the right quake fitting and the right secondary characteristics that you know go into our underwriting. That you know help prevent major damage in a quake. But you know I think yeah, for the most part, it's construction type and it's going to be weather, it's going to be natural disasters. During COVID we saw civil commotion, civil unrest be a factor that was something new.

Rachel Oh 22:05

Oh yeah, all the looting and all the Fires arson.

Ted Brown 22:07

So crime does have an effect on property, although not quite as much as liability. But the industry had a big builder's risk loss in the Bay Area a building that was, I think, 80, 90% complete and due to hot works the entire thing burned down. And you know those are. Those are major losses as well. So there's a lot of factors Like arson or sorry. What do you?

Rachel Oh 22:32

mean.

Ted Brown 22:33

No, they were welding, I believe.

Rachel Oh 22:35

Oh, and then it caught fire. Okay. And I could be wrong.

Ted Brown 22:41

Ouch, that sounds horrible what happened, yeah. So there's factors like that and that that has to go into pricing as well.

Ted Brown 22:56

Right, because still one of the main causes of loss in the insurance industry is fire, especially for wood frame. But from a state perspective, texas is bad, florida is bad, but going to Colorado Colorado is not really favorable right now from a wind or I mean, sorry, from a hail perspective. Parts of the Midwest are tough, but you know, you get into Pacific Northwest and it's a little bit safer. Yeah, you get into, you know parts of the Midwest, and things soften up a little bit. You know the upper Midwest. Then you get out towards you know New York and into New England and you know you're kind of the liability markets. Really what's going to kill you out there?

Rachel Oh 23:33

Yeah.

Ted Brown 23:33

But you know, from a property perspective it's.

Rachel Oh 23:37

Pretty chill yeah.

Ted Brown 23:38

It's not too bad so, but a lot of it, a lot of it's going to be driven by construction type these days.

Long-Term Real Estate Investment Strategies

Rachel Oh 23:44

Gotcha, you know that's super interesting and, of course, very relevant to PEG. So tell me a little bit about your partnership with PEG and how that like. So, for example, one of the things that I noticed we have a large pension fund that partners with us and when we were working on a large portfolio, they said, hey, we have a good relationship with so-and-so insurance company. We want to introduce you to them and see if you can't get favorable rates, which we did, and we were able to insure that entire portfolio through that group. And you know that wasn't something we'd really had before because I think we were more one-off deals and now we have larger portfolios and et cetera. And then I know this move to partner with Lockton is big for PEC. It's a big thing. I think it's going to help us on the bottom line. So just help me yeah, okay, good. So help me to understand, like, how that symbiotic relationship will ultimately impact our investors. Like how does that, how is that a creative to the real estate investment overall?

Ted Brown 24:40

Yeah, I mean, I think you know the best, the best client relationships and partnerships is when there's a couple of different things in play. One, a mutual understanding of what's driving the market. You have to have a partnership in this type of relationship and if you're just pounding the table and you know upset about rates, then it's hard to think critically and strategically about you know okay, what's our long-term plan here? How do we create?

Ted Brown 25:06

you know, some durability and you know, okay, what's our long-term plan here, how do we create. You know some durability and you know from a program architecture standpoint how do we make sure that you know you're beating the market or that you're financing risk to level out? You know the market impact that you know the market different market cycles can have, and that's one thing that Pegs you all have done an amazing job at really you know, learning, listening and being interested in the different strategies and solutions that go along with that.

Ted Brown 25:36

I think also another big part of it is you all embrace data and you embrace analytics and that's, at the end of the day, you know what drives a lot of the underwriting decisions.

Rachel Oh 25:47

Right.

Ted Brown 25:48

And so an understanding of your own exposure, understanding how you're underwritten in the marketplace. Then you can make informed decisions on what you do long term. And that's another big factor in the relationship. But I think there's also an alignment of values between our two firms.

Ted Brown 26:09

You all are looking at your investments from a long-term perspective. You're looking at your company from a long-term perspective, and so are we, and that allows us to come together and be thoughtful, be strategic and put together the best programs, best solutions that will help your insurability and competitiveness in the marketplace. So your investors will benefit from that partnership, because the things that we're talking about are things that are going to. You know, when the market's going up, you're not going to pay as much. When the market's going down, you're going to be some of the first to attract that capital.

Rachel Oh 26:45

Yeah, no, I love that You're going to be some of the first to attract that capital. Yeah, no, I love that. And again, I love that I appreciate you mentioning values, because values is definitely probably the most important thing to peg is making sure we align with the right groups that share the same values. And from my short interaction with you, I definitely feel like I can see why we're partnering with Lockton. Likewise, that makes me feel good because, again, when we're pitching to our investors and that's what my group does we like to try to be as holistic as possible. So I mean, let's face it, our returns are good, they're strong, but there are lots of other groups that have good, strong returns, and so how do we differentiate ourselves?

Rachel Oh 27:21

And I think this is as I'm listening to you, my wheels are turning. I'm listening to you, my wheels are turning. It's, like you know, we can talk about these kinds of things, because insurance does impact the overall bottom line in partnering with a group like you folks and helping us to be more competitive in the marketplace. I think will be really interesting. So it's just another thing I can, like you know, add to my value proposition, which.

Ted Brown 27:37

I love which I love, so this is great.

Rachel Oh 27:40

OK, so as we look ahead into the future, let's talk a little bit, then, about how do we then forecast for this. So we now know. On liability, you said it's about 12, 18 months lagging behind the property. We feel like property is getting to a tipping point, but you know we have large portfolios and we have big strategies, and so it's just an ongoing forward thinking process. How do you Sigurd or how are you going to be guiding us as we forecast specific to insurance and the way we insure our different properties and investments?

Ted Brown 28:10

Yeah. So the thing that you all and other investors need to think about is yeah, at the end of the day, insurance carriers are they really just want to pay the big claims? Right, they don't want to pay the day-to-day claims. And if you're just trading dollars with insurance carriers and you know one year they're going to win and another year you're going to win and, yeah, that's an unsustainable, you're just going to ride the waves of the market and you have bad losses one year, your rates are going to go up. You have good losses. The next year maybe they stay flat, maybe they go down in the soft market.

Ted Brown 28:45

So how do you look at that? Over a longer period of time, you have to finance risk, so you have to get the carriers out of attritional losses. So if you're having a bunch of small fires every year, that's what eats away at the carrier's profitability and, ultimately, what leads to increased rates if you're just looking at an individual risk basis. So with you all you know making sure that we understand clearly the loss picture and this is for all real estate investors, operators, owners understanding the loss picture. What's driving your losses, what's driving your exposure? How are you underwritten by the marketplace? And then you can start to look at all right, how can we finance risk? You know, over a period of time that's going to make us more attractive. So there are multiple different risk finance mechanisms that we're looking at for you all and that we look at for all of our clients. You can look at plus aggregate programs on a property basis, which is basically a large deductible that's capped and that you fund for that deductible.

Rachel Oh 30:02

Got it.

Ted Brown 30:03

And then if you reach it, if you reach a million dollars, so we cover all the little things.

Rachel Oh 30:09

We're going to be covering all the little things so that it's not going to be chipping away at the way a carrier looks at you.

Ted Brown 30:13

Yeah, If you're having a million dollars in losses a year, carriers are probably charging, which I hope we're not, by the way.

Rachel Oh 30:19

No, you're not Okay.

Ted Brown 30:20

Just as an example, but if you are, you know carriers are going to charge you $1.7 to $2 million to insure that.

Rachel Oh 30:30

Okay.

Ted Brown 30:30

So why trade dollars?

Rachel Oh 30:32

with them. Why don't?

Ted Brown 30:33

you finance for that, then you're funding a million dollars. Yeah, if you pay it, you know great, you know then carriers aren't paying that. If you don't, you keep that money.

Rachel Oh 30:46

Got it.

Ted Brown 30:47

Right. Then you can start to look at more sophisticated risk finance mechanisms. You can look at captive solutions. Yeah, so there's multiple ways in which you can seed captives and you can do that through renter's insurance programs, you can do that through security deposit programs and that allows you to build up retained earnings in a captive and then, once those retained earnings get to a certain point, then you can expand into other areas that might be a little bit riskier. Maybe on development, it's through subcontractor default insurance and you can reinsure your deductible there through a captive and you build up that further retained earnings. And then now all of a sudden you've got a. You know your captive has a pretty robust balance sheet. Then you can take bigger tranches of risk.

Rachel Oh 31:34

Got it.

Ted Brown 31:34

Okay. So there's ways in which you know, over time you have to have kind of an immediate, mid and long-term strategy around risk finance. But if you do that, then over the long-term you're going to outperform the market and you're going to be more aggressive on the deals that you're competing on, You're going to generate higher returns and you're going to attract more capital.

Rachel Oh 31:58

More capital, which is what I need, just like the insurance industry. So interesting. I did not think you were going to say that Somehow. I thought it was some other voodoo magic, but it sounds like it's super practical.

Ted Brown 32:09

Yeah, it's pretty simple.

Rachel Oh 32:10

I mean it's kind of the way I approach my health insurance. Right, it's very similar, yeah, very similar.

Ted Brown 32:16

It's not complicated and I think you know the insurance industry is a pretty traditional industry. I mean up until you know pre-COVID, I mean going over to London Lloyd's of London, you still had, you know, underwriters sitting out with you know, outside the boxes with their files and waiting in line to go and negotiate the deals, and you know all of that. And now you're seeing an evolution in the insurance industry. Ai is driving a lot of that. So there's a lot more.

Rachel Oh 32:45

How is AI driving that I'm so curious that, so there's a lot more. How is AI driving that I'm so curious. Yeah, so you know AI algorithms?

Ted Brown 32:51

Yeah, there's, you know, the carriers that have done it well, the brokers that have done it well, been aggregating data for a while, okay, and now that data is starting to tell a story.

Rachel Oh 33:00

Yeah.

Ted Brown 33:00

Now you're getting machine learning involved. You know predictive analytics that are going to be able to tell you things like okay, well, you know, if you build light gauge steel versus wood frame, what could that effect be in a hardening market or in a softening market? And we're starting to build solutions that can tell us that Underwriters are using it to underwrite and we're using it to advise.

Ted Brown 33:26

So it's not a complicated deal, but it has also been a pretty slow industry to adapt and because of that there's a lot of uninformed insurance buyers out there.

Rachel Oh 33:40

Yeah.

Ted Brown 33:40

Because they don't understand it and it's been hard to understand, but at the end of the day, it's all about how many losses you're having. Right Versus how much premium you're paying. How can you get the carriers out of that Finance, that risk on your? Own if you're able to, and then carriers win, you win.

Rachel Oh 33:58

Yeah, no, I imagine our underwriting team, because if you think about that, it's not that they're generalists, but they have to know a little bit of everything in order to plug in the right assumptions. And I imagine with insurance it's probably a line item, like I said. They probably like okay, well, who's the lowest, you know who's the cheapest, or whatever, and just plug that person in, we're going to use them and without maybe taking a step back and thinking through the implications of such and what does that?

Ted Brown 34:21

really garner you and then in the end, are you paying more because you didn't consider this, this, this so, and that can be a decent short-term solution, yeah, for a lot of companies, but when the market's fluctuating, yeah, you're gonna end up riding it. So taking a longer term strategic view of of risk is ultimately what's going to pay off yeah and those are the clients that that end up doing well in tougher markets Interesting, so insurance is a strategy. Absolutely.

Rachel Oh 34:50

So then, is insurance like so, like debt is something where you have you know terms, you know whatnot. Is insurance like that Meaning, if we have existing insurance policies with certain properties or portfolios, are we able to exit those, or are they like? You know, do you have to and I should know more than this, but I just don't? So, as an advisor, you know, do you have to and I should know more than this, but I just don't like so, as an advisor, would you?

Rachel Oh 35:11

are you going to come? I imagine you're coming in looking at our portfolio as a whole and, hey, these are the areas where we feel like you can, we can, we would suggest some improvement and you know, and is it nimble enough where you can change things? Sure, yeah, it is.

Ted Brown 35:38

You have to look at it again through a couple different lenses Most insurance contracts are going to have 90-day minimum earned, so you're not going to. You know, once's earned once hurricane season's over.

Ted Brown 35:49

So if you make a switch after that, you're not going to get any return premium for you know the hurricane exposure that was insured during that time, and so there's different windows of time, depending on how the contracts are written, that allow you some flexibility and the ability to be more nimble. That allow you some flexibility and the ability to be more nimble. Yeah, there's also timing with the marketplace. Yeah. So right now we're moving in the right direction. From a property standpoint, we want to harness that. Consolidation is important. When the market was shifting about three years ago, we started to look at client portfolios and 75% of the time and you know, scale one out. So your economies of scale are going to help you, but there's 25% of the time where it made sense to break things up.

Rachel Oh 36:38

Interesting.

Ted Brown 36:38

Well, so when you break things up you're dealing with, you know different carrier partners that you know will do smaller regional deals. They lag the market as well. So the excess and surplus lines markets right now are doing better. Certain standard insurance carriers, travelers, jobs.

Rachel Oh 36:59

AMTs of the world.

Ted Brown 37:00

They're doing better. And then some of those regional carriers are still. They're kind of lagging, so you know, that you know, piecing things together may have worked a couple of years ago, but now, because of where the market's headed from a property standpoint, those economies of scale are generating better results these days.

Rachel Oh 37:21

Interesting. Wow, ok, now I love that. It brings up probably my biggest exposure was again the largest portfolio we had ever raised for and where there was the most impact because it was an acquisition portfolio. So typically we do development. This was an acquisition portfolio. You've got aging assets, so you know the sounds like we have the benefit of partnering with a group like Lockton. But as asset managers, when we're training our analysts and underwriting teams, what information would be like if you could say, hey, as you're underwriting these, consider these things too. Like what? And that could be market driven, could be not just specific insurance, but tell me what are some things that you would suggest to them that can help them in their underwriting, as they're evaluating again both development and acquisitions.

Ted Brown 38:09

Yeah, I'd say that you know you want to let data drive your decision making. So really understanding the risk and exposure for you know different assets and making sure that you're making informed decisions. You mentioned this earlier. Right, you know, sometimes the cheapest solution might present itself, but sometimes the cheaper solutions don't actually address the exposure that you need and I can see that, yeah, we earn a lot of business because of that.

Insurance Impact on Real Estate Development

Ted Brown 38:37

So I think understanding the exposure basis is probably the most important thing and understanding what's driving either cost or loss or you know your exposure. If you look at development, you know construction type is going to be a big one, population density is going to be another, jurisdictions are going to be another. So you know Oakland, for example, a lot of population density, also a lot of crime, and that's where we saw a lot of arson occur. Same with certain parts of LA, and so that's going to factor into builder's risk, which is property insurance for development. Then you have construction defect, which you know. Again, certain states are going to have, you know, tougher construction defect laws than others. So understanding what the construction defect laws are in the states that you're working in is really important. And then how do you address that exposure? So liability is going to be on the construction defect side on anything that happens from a third-party standpoint. That's going to drive liability exposure. The construction type, like we've talked about, is very important.

Rachel Oh 39:47

No wood, that's what I've learned. No, I'm just kidding. We do a lot of wood, by the way.

Ted Brown 39:53

Yeah you do, and a lot of our clients do, because it's the least expensive way to build something.

Rachel Oh 40:00

Well, height too right, like it's easier, like most areas are zoned for certain height restrictions and so oftentimes it's just an easier like we're not really this high rise state, at least our areas. Of course now we're doing more significant building outside the state. But yeah, I mean I hear stick construction all the time, but earlier you had said that it doesn't really matter because there could be other factors that impact.

Ted Brown 40:25

It does matter, but there are other factors that impact it, that we can consider at least. Yeah, I mean you look at like-gauge steel, like-gauge steel. There's some incredible companies out there that are doing that, have really amazing technology from like H-Steel perspective Build I think it's BYLD is one of them that you know their technology. Basically, you know input in the architectural you know drawings, and it comes up with a package that is already pre-cut, pre-fabricated, that it just gets assembled on site, and so it's not just the cost of the material.

Rachel Oh 41:04

It's also the cost of labor and what goes into it. Well, labor is expensive. Labor is very expensive. I mean, I think labor is one of the biggest things that impacts everything that we do, including down to operations, not just the building phase.

Ted Brown 41:16

No, it's management. Yeah, it's all the things. Yeah, you know that. You know some of that labor is contract labor, you know we're subcontractors, some might be your own employees.

Rachel Oh 41:26

Yeah.

Ted Brown 41:27

You know that's another factor, but you know, I think from a construction type perspective there are a lot of things that can influence things positively in terms of the evolutions that are happening in that marketplace. So, you know, you look at core, core plus construction. You know high rise construction, I mean those are going to be easy to ensure. Yeah.

Rachel Oh 41:47

They're going to be safe. They're easy for us to underwrite as well.

Ted Brown 41:50

Yeah, exactly.

Rachel Oh 41:51

Well, at least in terms of longevity and in the investment, yeah, okay, great. So, as we kind of wrap things up, what are the lessons that you and your company have learned, probably in this last period, as I think you called it the hardening market or, you know, as we're kind of, at least on the property side, coming out of it a bit and you're kind of looking at liability, but what are some lessons learned and takeaways and advice you would give to real estate investors today?

Ted Brown 42:17

Yeah, so I think we've talked about a lot of it, but letting data inform decisions around risk is really important and it's not a black box. It's fairly simple to understand what's driving exposure and therefore cost, making sure that you're taking a long-term view not just of the way that your program is architected, but also of the relationships in the industry. You know the underwriters don't write a portfolio like yours to make money in one year.

Rachel Oh 42:51

No.

Ted Brown 42:52

They're doing it from a long-term perspective.

Rachel Oh 42:53

Yeah.

Ted Brown 42:54

And so sitting with those underwriters, sitting with those executives and understanding how their business works ultimately helps create the best carrier partnerships out there. Because, when we look at all of our benchmarking data, you know, yes, people that are controlling risk, that's something else that we can talk about briefly. But people that are financing risks, yep, they certainly see better rates. But the people that have stuck with historic relationships over time, those are the ones that have beat the fluctuation in the markets, and so you know if—and we have some clients—.

Rachel Oh 43:34

And that's a risk control. It sounds like from kind of what you're saying.

Ted Brown 43:37

No, Not necessarily. No, risk control is separate. That's what you have to do to control risk. So you know what are you doing to control fire? What are you doing to control water? Damage water leakage, all those things. How are you controlling the cost of claims? That's very important, but all of that gets funneled into that relationship. Okay, and unless you're sitting in front of those underwriters telling that story yeah talking about all the things that you're going to do to improve your, your exposure base yeah you're not really going to.

Ted Brown 44:06

You're not going to see the benefit of it. It's just going to be in a, in an underwriting submission. So at the end of the day, this is a relationship driven industry.

Rachel Oh 44:14

It is people industry and like all industries are, is what I'm learning everyone that's coming here. That's end of the day. This is a relationship-driven industry.

Ted Brown 44:22

It is.

Rachel Oh 44:22

It's a people industry, like all industries are, is what I'm learning Everyone that's come in here. That's one of the themes I hear and I would not have.

Ted Brown 44:26

I mean, I see that insurance now, but I don't think I would have thought that, yeah, it's critical and the clients that have that philosophy and that take a long-term view of their business and the carrier's business, then those are the ones that find alignment with carrier partners and that's critical. But you've got to do the stuff on the other end to control losses and going back to technology. There's great technology out there that, from a leak detection standpoint, water damage is a huge cause of loss.

Rachel Oh 45:00

Yeah.

Ted Brown 45:00

From a fire standpoint, from then also controlling the claims. So, making sure that you're not, you know, looking to inflate claims just to make money making sure that you're controlling those costs, because those costs go into your loss experience. Your loss experience is what's going to be used to underwrite. Yeah and you're going to end up paying for it one way or another, and so making sure that you have good alignment with those carrier partners around. All right, this is what we're going to do. This is our litigation strategy.

Ted Brown 45:29

This is what we're going to do from a loss control standpoint. This is how we're going to handle claims. That's where the rubber meets the road for them. Ultimately you can't do anything about a hurricane.

Rachel Oh 45:38

You can't do anything about hail. But if we have all those controls in place or policies, or we've thought it through, and we have those mitigation things, then that's what you're saying.

Ted Brown 45:48

It's additive to just the hard numbers. That's right. It's blocking and tackling.

Rachel Oh 45:52

Okay, yeah, I, blocking and tackling. Okay, yeah, I like that. But I think I think the other thing that I've learned is that it is cyclical. Okay, I'm glad that you said that it will get better. I feel like in at least in construction, we've kind of accepted the fact that construction costs are here to stay, like it is not going, like this is the new norm. We know that interest rates, in a way, are cyclical, but we don't see any reprieve there. But the fact that you're telling me the insurance costs are cyclical, that's like music to my ears. Yeah, that's amazing, yeah.

Ted Brown 46:19

Well, I think I mean interest rates. I think it was Citibank or one of the big banks just said that they expect over the next 12 to 18 months 200 basis points and rate cuts. I mean that's cyclical in a positive direction. So it's all cyclical.

Rachel Oh 46:37

I would love 200 bps. Repeat that's awesome, yeah, okay, let's make that happen. What can you do to that? I can't control that. Come on, come on, ted. Okay, well, awesome, well, I love that. I appreciate your time and helping us to better understand insurance as it relates to commercial real estate and the investment side. I've learned a ton, and I imagine our listeners have as well.

Ted Brown 47:02

Thank you for having me. I hope I was helpful.

Rachel Oh 47:03

I very much appreciate it. So, again, from the peaks of the Mountain West, I am Rachel oh, host of Peaks and Portfolios by Pet Companies. Thank you again, ted, for joining us and for all those who joined in, and we'll see you all next time.