The real estate market handles large volumes of investment and accordingly, there are sizeable consequences for potential losses. An optimal and civilized way of minimizing risk at all stages of a building’s serviceable life is through insurance.

Types of risk

In the real estate sector, property insurance is standard. Insurance in this case extends to a building’s constructive elements, service infrastructure, furniture, office technology, internal and external finishings and so forth.

The main types of risk that can be envisaged under this heading are fire, water damage, lightning strike, a gas explosion, natural disasters, criminal actions on the part of third parties, robbery, vandalism, etc. It would also include insuring risks of terrorist action.

In addition to cover for basic property insurance risks, specialists also identify a type that is particular to the real estate sector – insuring the consequential losses of business interruption for a real estate building. If the building is damaged, meaning that it cannot operate as usual, insurers will indemnify the loss of profits formerly perceived on a stable basis in the form of rent. “The conditions of a standard agreement are to cover the owner’s losses if the loss occurs directly in the building as a result of which tenants cannot conduct their activity and thus pay their rent rates”, explains Alexander Poludenny, head of business development at ROSNO. “But there is also extended cover – for example, insurers will indemnify the Insured’s losses for the consequences of a neighboring building’s collapse due to fire, natural disaster or act of terrorism making it impossible for tenants to access their premises”.

Experts believe that the presence of foreign players on the national real estate market, who normally have high standards with regard to the level and quality of insurance guarantees, is encouraging insurers to release new products that are still a rarity for the national insurance market. “For example, in the West’s retail sector loss of attraction insurance is popular” notes Vadim Sukhikh, senior underwriter of the Russian branch of ACE insurance company. “This can cover a shopping center’s tenants’ loss of profits in the event of a loss such as a fire affecting an important tenant. This type of insurance is very useful because a small shop’s activity depends directly on visitor flows, which are generated by the anchor tenant. If the “anchor” cannot operate, other shops will also be left exposed.

In addition to property insurance and insuring risks against interrupted rental income, insurers also provide another type of guarantee referred to as third party liability. This insurance will cover the liability of owners, management companies, contractors or tenants towards third parties in the event of material damage.

This type of liability insurance is popular among property owners. They can insure their liability towards tenants and visitors who may sustain material damage or personal injury attributable to the owner. “It is likely that if a visitor sustains damage within the building, a claim will be made against the owner rather than the tenant”, notes Dmitry Stanin, head of non-industrial insurance at Ingosstrakh.

Management companies also insure their liability. Their business is to operate the building as a complex, which is why experts believe that it is wise to insure liability towards third parties including the building’s tenants and owner.

Experts also advise tenants to insure their liability. “Even a very small company, renting a small space can nonetheless cause serious and even catastrophic damage to the whole building complex, which can be very difficult to compensate from the business’s own turnover and reserves”, observes Mikhail Alexeev, head of property and liability insurance at Kapital Insurance.

Insurance phases

Real estate insurance comes into play from a project’s earliest stages. “For example, risks are identified at the planning phase, which can refer to defective design on the part of architects and designers. Authors of architectural projects can and should insure their liability”, explains Alexander Poludenny.

The next stage involves the building’s direct construction. “Insuring risks is possible throughout the entire construction-erection process, from the moment of delivering construction materials and equipment to the site to the conclusion of the guarantee period” explains Oksana Mysova, DVI GROUP’s director of marketing communications. Here, insurers differentiate between construction and erection risks, professional liability of main contractors, etc. “A particular feature of construction insurance is that it includes guarantees for specific technical risks” continues Oksana Mysova. “Technical risks can refer to defective workmanship during the construction phase, electrical or mechanical breakdowns, subsidence, material damage to the contract works, etc:”

Losses incurred by interruption of construction work or delays in building handover can also be insured; this type of insurance is comparable to business interruption for commercial activity but covers the building during the construction phase.

Another type of risk that professional companies insure is related to the property’s operation. It is important to remember that fully insuring a building throughout its operation is above all a way for owners and management companies to protect their investment. Of course, insurance cannot protect clients from events of force-majeure, natural disasters or a fire, but the existence of insurance protection enables a bona fide source of financial flow to be obtained at a difficult time in order to minimize losses.

Pricing

The largest part of the insurance cost in the commercial real estate sector refers to the insurance of the property against the main risk of fire. Not surprisingly, the insurance cost in this case will primarily depend on the extent to which the building has fire protections. “The existence of a sprinkler system for fire extinction can reduce the cost of the insurance by up to 30%”, notes Alexander Poludenny. “Moreover, the risk appraisal will depend on the type of building. Fireproof materials and non-flammable claddings can also reduce the insurance premium”.

If the insured risk is water damage, the condition of the heating and water system will be appraised, together with operating conditions and the existence of qualified personnel. Business interruption insurance takes into account the volume and structure of rental income, and the interruption period (3, 6, or 12 months and in exceptional cases 24).

In general, to appraise the cost of insurance the main criteria are: the scale of the potential loss, age and construction of the building, its value, functional designation, number of floors and location, its protection systems (security, fire extinction), particular features of its operation, etc. Where insuring liability is concerned, for example, for management companies, these factors will include the area of the building and its surrounding territory, the number of tenants and their type of business, the management company’s experience, number and qualifications of its employees. In order to determine the cost of insurance it is important to fill in a proposal form for each particular type of insurance or risk. “Another important factor that determines the cost of the insurance is the deductible. The size of the deductible is generally stipulated in financial terms and represents the percentage that the insured (owner, management company) contributes to the loss. Usually the deductible is obligatory, and its amount is deducted from the financial loss. For example, if the stipulated deductible according to the insurance contract is in the amount of US $500, this means that the insured will pay US $500 towards the compensation for the loss, irrespective of the size of the loss. Losses in excess of US $500 are paid for by the insurance company. Therefore, the lower the deductible, the higher the cost of the insurance and vice versa” explains Dmitry Stanin.

Insurance premiums vary depending on the type of risk, between 0.1 and 0.6% of the total value of the insured property. This value is verified through a special survey, or according to the value of the property on the balance sheet.

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In some cases, insurance deals may not go ahead at all. This can be at the insurer’s behest, for example, when the building’s protections do not meet the insurance company’s requirements and the likelihood of a claim occurring is close to 100%, and at the insured’s when the cost of the insurance may seem too high. “For example, a client may wish to insure an old wooden building from fire but has no fire alarm, the insurance company may wish to enforce strict conditions and in such cases, the client may turn down the insurance offer” comments Alla Fokina, deputy head of property and liability insurance for corporate clients at Rosgosstrakh Holding Company.

Insurance payments

The technique for calculating insurance payments is based on a number of factors: firstly, the value of the property is evaluated, the sum insured is established (normally, equivalent to the value of the building), then it is multiplied by an insurance coefficient, and only after this the insurance premium is calculated, which in turn can be paid in a single lump sum or in installments. “The way of paying the insurance premium is also agreed separately in each individual case – many insurers are cautious about accepting insurance premium payments in installments (moreover, payment in installments can also affect the cost of the insurance)” says Dmitry Stanin. “A defining moment here is the premium’s total sum”.

Conclusion

Experts note that there is a great deal of interest in insurance on the part of real estate market players. However, there is still no stable demand equally shared among all the various types of insurance. For example, we cannot say that liability insurance is well-developed.

Nonetheless, experts are certain that in the near future we can expect to see dynamic growth of this insurance segment. “Worldwide, and especially in the US, the volume of investment premiums for this type of insurance is often greater than that received for property insurance. Obviously, this is related to the degree of development of the legal culture, and the level of development of the court system in that particular country. With Russia’s transition to a market economy the legal obligations in terms of liability for the business activity are increasing, which, naturally, will promote the development of this type of insurance”, explains Vadim Sukhikh.

Another important role in the increasing popularity of insurance services according to experts is played by insurance companies’ effective policy of offering cover not only for separate types of losses, but also by offering a range of programs. “In my opinion, the prospects for the development of the insurance services are related to a complex approach that enables a variety of insurance programs to be offered,” comments Dmitry Stanin. “With their help it will be possible to effectively protect the interests of all parties participating in the execution of commercial property.” “Insurance is one of the cheapest and most accessible instruments for minimizing risks during construction. Without a doubt, the development of this services market will grow at a fast tempo”, concludes Oksana Mysova.