Many factors affect the type and cost of insurance for commercial strata properties – some good, some not so good. However, there are also ways strata committees and strata managers can reduce tenants’ impact on the broader insurance program.
Is your property positioned in the best possible light?
The insurer’s perspective
Insurance is about the transference of risk. When insurers look at a property, they do two things.
- Evaluate risk, ie the likelihood of a claim.
- Calculate the premium needed to cover the costs associated with the perceived risk, ie the reinsurance costs.
The higher the risk, the lower the insurer’s risk appetite, which can lead to a higher premium or no offer of cover.
Tenants are a significant factor when insurers assess the overall risk associated with a commercial property. So, it pays for strata committees and strata managers to be well-informed.
Understanding the insurance cycle
Insurance moves in cycles, driven by external factors like climatic and economic events.
As insurer profitability declines following catastrophic claims events, insurers tend to look for ways to reduce their overall risk, and the market hardens.
As insurers’ profits strengthen, the market softens. Insurers start to write more business, new entrants emerge, and premiums start to plateau or even decrease.
We’re currently in a hard market, and the challenging conditions look set to continue.
- Affordability – this continues to be an issue for customers. Premiums have increased due to the number and severity of recent natural disasters, problems with building defects and overall market conditions.
- Costs – there’s less capital available in the market due to poorer returns. This has led to a significant increase in reinsurance costs, which insurers are having to pass on to customers.
- Availability – insurers have become more selective in the risks they agree to take on. This has led to tighter underwriting criteria and has made it more difficult for some buildings to get insurance cover.
The influence of the Australian Reinsurance Pool Corporation (ARPC)
The government-backed Cyclone Reinsurance Pool (CRP) was implemented so insurance companies could transfer their cyclone risk exposures. It’s a reinsurance arrangement between insurers and the ARPC and was designed to address pricing concerns in northern Australia but not to reduce risk in the region.
As of June 2024, analysis of online insurer quotes released by the ARPC shows general insurance availability is improving for people living in cyclone-prone regions across Australia. But it’s important to understand that the CRP doesn’t change a poor-quality risk into a good risk, nor does it address broader construction quality concerns or the lack of risk mitigation for flood.
The CRP won’t necessarily change an insurer’s view of a property’s risk level. However, it should make insurance more affordable and accessible for those whose property presents an acceptable level of risk to insurers and is therefore “insurable”.
A closer look at the impact of defects
Insurers want to keep customers that represent a “good risk”. That means a property that’s well maintained and has a good claims history.
Owners have a statutory requirement to repair and maintain their property, address issues when they arise, and avoid problems caused by neglect.
If an insurer requires a customer to rectify issues as a condition of insurance, it’s now insisting that rectification work is underway before it will accept the ongoing risk at renewal. Customers are likely to be asked to provide evidence that active steps have been taken to rectify the cause of a defect.
Customers should ignore this at their peril. Doing nothing can come at a considerable cost to the strata scheme.
- Less choice of insurers
- Higher insurance premiums and excesses
- Imposed conditions of insurance
- Reduced level of insurance cover
- Claims declined
- Difficulty selling the property
The importance of valuations
Within each State or Territory, strata legislation mandates that buildings be insured for their full replacement value. The strata scheme’s responsibility is to ensure the insurance policy sums insured are sufficient to fully reinstate or rebuild the property following an insured event.
- Replacement – rebuilding when the building is destroyed.
- Reinstatement – rebuilding when damaged but not destroyed.
Owners are responsible for adequate sums insured and are jointly and severally liable for any underinsurance. A building valuation can help with this. A qualified and skilled valuer assesses the cost of replacing the building using their knowledge of the industry and construction guidelines. They look at the construction and quality of the existing property and assess the cost and time to replace it “as new.”
- Demolition and removal of debris costs
- Building design, including any specific requirements
- Replacement cost of the buildings and common areas
- Professional fees, such as architects, surveyors and engineers
- Government fees and taxes
- Inflationary provisions for the duration of the valuation period
Delays in increasing a policy’s sums insured based on a new valuation could create a liability for both the strata manager and broker if there’s a claim. The reality is that the cost of not updating the building sum insured will be much more than any additional premium.
Finding the right tenants
High-risk retail/commercial tenancies within a strata property, such as massage parlours and tobacconists, can significantly increase insurance premiums. This increase is driven by both a higher frequency of claims and heightened moral risk associated with potential criminal activity.
Increased claims frequency
- Property damage. High foot traffic and the nature of activities in adult service venues increase the likelihood of property damage. As such, vandalism, illegal activities and accidents are more common.
- Fire hazards. Tobacconists carry a high fire risk due to the storage and sale of flammable products. Improper disposal of smoking materials can also lead to accidental fires.
- Major incidents. Both types of businesses can see frequent major incidents, such as arson, armed robbery or police disturbances, requiring emergency services and often leading to insurance claims.
Moral risks
- Criminal activity: Adult services venues and tobacconists are sometimes linked with illegal activities such as drug use, human trafficking or other illicit operations, which increases the likelihood of police raids and associated property damage.
- Theft and vandalism: Tobacconists and convenience stores are prime targets for theft due to the high value of their stock, particularly cigarettes and tobacco products. This increases the likelihood of break-ins and vandalism.
- Legal issues: High-risk businesses may face frequent legal challenges or compliance issues, which can lead to potential lawsuits and increased legal fees for property owners.
What this means for insurance premiums
- Higher risk assessments. Insurers assess the risk levels of the tenancies within a strata property. High-risk businesses elevate the overall risk profile, leading to higher premiums.
- Risk selection. There’s a very limited market for strata insurers willing to provide cover for high-risk activities. Many buildings with high-risk tenants are finding it increasingly difficult to secure the required legislative insurance in the current market.
- Frequent claims. An increased number of claims, both in frequency and severity, directly correlates with higher insurance costs.
- Cost of risk management. Strata properties may need to invest more in security, fire safety measures, and other risk mitigation strategies, which will increase operational costs and insurance premiums.
