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When I made that post of mine in Dec 2000, which I referenced in my last post, I thought we were watching the conclusion of a cycle. We had been experiencing a cycle such as I described in Part One of this article, and we seemed to have bottomed. The housing programs which got started in the late '90s, and then the steady drop in rates from the time of the market crash, had strained the rental industry, but not to the breaking point and, although vacancies had gone up, things were clearly turning around. Through the first part of 2001, the rental business improved steadily.

After 9/11, everything changed. I noticed the impact immediately - and I mean within days. The phone stopped ringing. No appointments to show apartments. No applications. No leases. It showed in a large trail-off of the business in the screening service as well; clearly the problem was at least regional.

Then the layoffs started to hit. Move outs due to loss of job, moving in with relatives. Vacancies shot up. Then more Fed rate cuts to stimulate the economy. More churn on the low end as mortgage rates fell and more people were suddenly able to qualify for a mortgage. Suddenly, the cyclical improvement we had been seeing was aborted, and we were taking another turn around the maypole as pressure on rents increased yet again.

But all of this was relatively superficial. There was a much bigger problem brewing below the surface, and this problem is just starting to surface. I first became aware of the problem less than four months ago - I would never have predicted it - and I am among the early ones affected, just because of where in the calendar my renewals fall.

Now, understand that I am starting to talk in an area where my knowledge is incomplete; much of what I have to say has been given to me by people in the industry and I am just repeating it. I am, though, seeing the effects "up close and personal."

The insurance industry is in big trouble, and this spells disaster for the real estate industry if it is not dealt with very soon. Evidently, the fall of the Twin Towers did enough damage, in aggregate, to wipe out part of the reinsurance industry.

When you purchase insurance, if the insurance carrier decides that their exposure is excessive, they will lay off part of their risk to a reinsurance firm, thereby spreading the risk. The reinsurance is relatively inexpensive since it only comes into play if the damage exceeds some relatively large threshold.

Well, the damage caused by the terrorist attacks evidently was substantial enough that - in the words of one agent I deal with - "several reinsurers were wiped out." I find this to be strange, but this is what he says.

Now, it is also true that insurance companies historically derive considerable portions of their income from their investment portfolios - which curiously enough often includes substantial positions in investment real estate (either directly or through mortgages). The stock market crash has pretty much eliminated that source of income.

Also, over the last several years, claims (mostly fires) from investment properties have been on the rise. Why this would be is out of scope for this post, but I for one am satisfied that this is probably true. The short version is that the average quality of tenant has declined over the last several years as the better tenants buy houses. Poorer quality tenants generally are less responsible in every aspect of their everyday lives, and...well...you do the math. Fire claims are going up.

Another agent I have been dealing with says "State Farm alone lost $600 million last year." Again, I have made no attempt to verify the statement; I just report what I was told.

The upshot is that insurance for investment properties is becoming extremely difficult to obtain at any price and, when it can be found, that price is unaffordable. TMFTom9 reported in his article today that I told him my insurance has gone up 100% on renewal. What he didn't report was that my old policy had $1,000 deductible, replacement cost coverage, with $2 Million liability and included coverage for my five truck, two car fleet. My new policy is up slightly more than 100%, has a five thousand deductible, $500K liability, no vehicle coverage, and coverage on properties that really doesn't meet their actual value although it does meet the mortgage values. Also, there is one property that so far I have been unable to purchase insurance for at any price.

Not only that, I am told it is going to get worse, possibly much worse.

To put it bluntly, I can't afford it. I should also point out that we have a very good risk history; we have two claims in the last twelve years (both fires) and our premiums paid have greatly exceeded the cost of the two claims combined (by a factor of about 5). Also, we have never been successfully sued, and keep good records.

The insurance industry is in trouble. They are hemhorraging money, and becoming very risk averse. Landlords are now being faced with the choice of buying insurance they can't afford and can't pass on as rent increases, or being either "force placed" by mortgage holders or foreclosed on for mortgage violation by those same mortgage holders.

You do the math. And according to all the agents I have spoken with, it is going to get "much worse before it gets better."

If this situation is not brought under control very quickly, the investment property industry will collapse. The industry has been under pressure starting in the late '90s with the new mortage programs. The pressure increased after the market crash as rates fell quickly, and then the recovery of 2001 was aborted by 9/11. And now, there is a massive cost shock just starting to work through the industry, at a time when much of the industry is short of cash and struggling with cash flow.

In my next post, I'll talk a bit about what I see as the implications of all of this.
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Jiml8.
Nice post.
A link was put on my board and I followed it here.
Stop buy sometime and do a post or two.

Thanks.

Mish
M
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Another agent I have been dealing with says "State Farm alone lost $600 million last year." Again, I have made no attempt to verify the statement; I just report what I was told.

State Farm settled on some class action suits last year resulting in returned premiums for some policy holders. This may have been part of their "loss".

Duck!
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If you are reducing the potential housing crisis to the difficulty of obtaining affordable insurance, I take issue with this:

jiml8 writes:
To put it bluntly, I can't afford it. I should also point out that we have a very good risk history; we have two claims in the last twelve years (both fires) and our premiums paid have greatly exceeded the cost of the two claims combined (by a factor of about 5). Also, we have never been successfully sued, and keep good records.


If you've got two fire claims in your risk history, that isn't good. According to my agent you are virtually untouchable by any standard means of insurance. So it isn't exactly accurate to hang this on a tightening insurance market. However you'd be correct in saying that the declining quality of renters is a problem.
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Aha! An area that I can actually contribute on-the insurance industry. I'm an insurance analyst by trade and I have analyzed both the life and property casualty sides of things, and I've been paying attention for several years.

I really don't believe that the insurance industry could be the trigger for a real estate implosion. Yes, the collapse of the towers sure did make it clear who was running around with their pants down and who had everything buttoned up right. However, that event only hastened a trend that was already unfolding: rising insurance rates. For years (10?) too many insurers and reinsurers have been chasing too little business and too little market share. Every company wanted and needed scale in order to make up for the lousy pricing in the ndustry, so every year they cut rates a bit more. This downward spiral went on for a nu,ber of years and it flushed a LOT of capital out of the industry via accumulated losses. By early 2000, most lines of the business had about bottomed out. Marginal players were toast, moderately strong companies were largely in trouble, and the titans (like AIG, Berkshire Hathaway and Swiss Re) had invested a huge amount of money (in losses) in return for the dubious honor of being the last men standing in an industry that was cutting its own throat.

Given this state of affairs, the pain had finally become so great that companies lost their appetite for price-driven market share gains. Rates started to go up and companies finally started to rebuild their balance sheets, in many cases quietly covering up inadequate reserves. When the commode hit the windmill (so to speak) in September last, the industry was weakened but starting to pick up the pieces. After the Big Hole In The Ground appeared about a block and a half from where I now sit, most players in the industry realized that they had a lot of business on the books and not that much capital to support it. This is very similar to the state of the industry early in 2001, but far more serious. So rates started shooting up as everyone along the chain tried to ration what was left of their capital strength to the customers willing to pay for it. This continues today.

However, rates can only go up so far. There are economic alternatives to playing with the insurance industry ast it is. One, customers can simply bear the risks (or more of the risks) themselves. This is more feasible in commercial lines as opposed to personal lines because most personal lines are compulsory. Jim, you have already done this by accepting a less comprehensive policy. Two, the capital markets are at least reasonably efficient over the long term, and outsiders are being attracted to the insurance industry due to the high returns currently being offered. Starting in the fourth quarter of 2001, a whole slew of new reinsurers have been set up in Bermuda, bringing something like another $20 billion of capital into play. These are (mostly) not two bit operations; they are backed by the likes of Goldman Sachs, AIG and other brand names. Three, there are a whole host of mechanisms for what the industry calls "alternative risk transfer." Although these solutions mostly apply to mid-sized and larger organizations, Marsh-Mclennan, Aon and other smart cookies are out there setting up risk pools, cat bonds, captives and all manner of other means by which risk can be spread out and leveled off for a price.
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If you've got two fire claims in your risk history, that isn't good. According to my agent you are virtually untouchable by any standard means of insurance. So it isn't exactly accurate to hang this on a tightening insurance market. However you'd be correct in saying that the declining quality of renters is a problem.

With the size of operation I have, 2 fires in 12 years isn't bad at all. It's all about statistics, right? Also, they are "history" and I have renewed a couple of times since the last one. Not only that, but my agent has historically referred to my account as "very profitable."

I have the word that several of the other major properties in the area are now getting cancelled... This is just getting rolling. I was one of the early ones.
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The insurance industry is one that I don't follow. I merely use it.

I really don't believe that the insurance industry could be the trigger for a real estate implosion.

Taken by itself, I would certainly agree. And I would reiterate two points; first, I am not predicting a collapse - I merely think there is an excellent chance at this point. Second, the insurance industry wouldn't be to blame, per se, but merely the catalyst that triggers an event that seems to be in the works anyway - at least, for large regions. By making it happen more quickly and in a more widespread fashion, this will exacerbate the impact at a time when economic conditions overall could be somewhat frail.

Yes, the collapse of the towers sure did make it clear who was running around with their pants down and who had everything buttoned up right. However, that event only hastened a trend that was already unfolding: rising insurance rates. For years (10?) too many insurers and reinsurers have been chasing too little business and too little market share. Every company wanted and needed scale in order to make up for the lousy pricing in the ndustry, so every year they cut rates a bit more. This downward spiral went on for a nu,ber of years and it flushed a LOT of capital out of the industry via accumulated losses

Overcapacity in the insurance industry? Interesting.

Nevertheless, that doesn't seem to account for what is happening now.

There are economic alternatives to playing with the insurance industry ast it is...Marsh-Mclennan, Aon and other smart cookies are out there setting up risk pools, cat bonds, captives and all manner of other means by which risk can be spread out and leveled off for a price

How would this work, how could they be contacted?
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How would this work, how could they be contacted?

******************

Jim, the key to making alternative risk transfer (ART) mechanisms work is if they cost you less than comparable insurance would. Most of the time, you have to have significant scale to make this work, and it sounds as though you might be a candidate. Aon and Marsh are public companies, so it shouldn't be too tough to reach out to them. I'd imagine a brief rummage through their websites would probably more than do it.

As for how the ART market works, well, it depends on who you are, what state you are in and what coverage you are after. As an example, a really common strategy for the workers' comp market would be for a business owner to set up a captive insurance company based in Bermuda or the Caymans. Losses would be retained up to a certain maximum, and the rest would be covered by a stop loss policy placed with a reinsurer. The business owner would technically own non-voting preferred stock of the captive, and a service provder (like Marsh, or Mutual Risk Management before it blew up) would hold the common stock and take care of the paperwork. This arragement is called "rent-a-captive." Now in your case, for example, I don't believe you could do this for workers' comp risk because IIRC you are in Ohio, which IIRC (again) has some funny laws about workers' comp (little things like no private insurers are allowed to compete with the state fund).

If I were you, I'd at least seek out an ART market participant/service-provider and see what they have to say. It might not work out for you, but its worth a shot.
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jiml8 writes:
With the size of operation I have, 2 fires in 12 years isn't bad at all. It's all about statistics, right? Also, they are "history" and I have renewed a couple of times since the last one. Not only that, but my agent has historically referred to my account as "very profitable."


They have justification to gouge on the premium based on the potential for huge damages, yet they probably won't end up paying any significant claims. Yes, I would not be surprised to learn that an account with a few fire claims is a very profitable account. But I'm not so certain that "profitable" is a good thing for a customer to be.
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They have justification to gouge on the premium based on the potential for huge damages, yet they probably won't end up paying any significant claims. Yes, I would not be surprised to learn that an account with a few fire claims is a very profitable account. But I'm not so certain that "profitable" is a good thing for a customer to be.

Again, I have been paying standard rates. In fact, my rates have historically been somewhat low. A couple of times I have shopped my business (including just a year ago) and no one could touch what I was paying.

It is all about statistics. I go something like ten thousand unit months between fires, based on my history. That isn't bad.
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