Properly functioning markets are the best antidote to systemic risks, but as facts change it behooves us to revisit market structure and regulation to remove structural impediments to proper market function. As we mentioned in the previous blog post, the yawning gaps in insurance coverage for properties that are most at risk are likely to deter prospective buyers, resulting in depressed real-estate values and reduced tax receipts. If unchecked, this has the potential to trigger a cascade through the local economy.
HUD’s New Policy for Multi-Family Borrowers
The US Department of Housing and Urban Development (HUD) recently updated one of the insurance requirements for federally backed mortgages. The amendment, which is effective as of April 17, 2024, increased the maximum allowable deductible on a ‘wind and named storm’ policy to be greater of $50,000 or 5% of the insurable value per location (compared to 1% previously), up to a maximum amount of $475,000 per occurrence (compared to $250,000 previously). This is applicable nationwide to new multifamily mortgage insurance transactions that are pre-endorsement. The amendment excludes the existing borrowers as it does not apply retroactively.
How does this affect new borrowers?
Insurers started including special wind and ‘named stormed’ deductibles in their property insurance policies due to the alarming increase in storm intensity and severity, especially in coastal regions. Nineteen states and the District of Columbia offer policies that have a separate ‘named storm’ deductible as shown here.
The low deductible limits that were in place (prior to the recent change) forced premiums higher, compounding the problem of insurance affordability and availability, as insurers abandoned some risky markets altogether.
The regulatory policy change confers multiple benefits on the borrower. First, it allows borrowers to work with insurers in some markets that were deemed uninsurable by the private insurers. Second, to satisfy the mandated low deductible limit the property owners were forced to be out-of-pocket a steep premium for a separate buy down coverage, planned expenses that they will not have to incur going forward. Third, it allows new borrowers to obtain mandatory coverage at lower premiums, the ‘savings’ from which can be re-invested in resiliency retrofits. Reduced competition in areas most at-risk and response of insurers to elevated risks and replacement costs, can offset some of the anticipated reduction in premiums.
But will this be enough?
Affordable housing operators are often constrained in their ability to pass costs through to tenants. Many are facing the perfect storm from surging insurance premiums along with other escalating operating costs and financing costs. This measure will provide some relief to qualifying properties, however, stressed borrowers juggle competing priorities and all available resources are likely to be funneled to serve existential needs. Survival in the short-run will outweigh optimizing for the long-run. While we agree that lower ongoing (premium) expenses and a higher deductible will align incentives to invest in resiliency, the question remains, will it be enough to spur action?
We believe that by increasing the deductible ceiling and potentially lowering the insurance premium, HUD has redistributed the risk. The property owner now retains more physical risk[1] in the form of increased deductibles and exposure to major climate events. Transition risk[2], however, remains unchanged. In many areas property values have not yet adjusted to reflect the anticipated climate risks.
Conclusion
Shifting risk to achieve greater alignment of premiums and claims is necessary for a robust and competitive insurance market. However, the much vaunted ‘savings’ in premiums may prove illusory or fall woefully short as insurers reprice risks. This warrants a close scrutiny of market participants. Should the desired behavioral impact of this policy change fall short, a more robust market signal to property owners through regulation will be in order. This may include policy actions for updating building codes, reclassifying flood plains, and providing need-based support to eligible properties.
Footnotes
[1] From the real estate perspective, physical risk represents physical damage to a property or changes in physical conditions in such a way that a property’s economic viability is diminished. See this MBA research paper for a more detailed discuss of these risks.
[2] Transition risk is best thought of as changes caused by climate-change that don’t physically affect the property but do change the conditions in which the property operates, such as changes in insurance costs or availability, tax rates, land use restrictions, building code requirements and potential property value declines. See this MBA research paper for a more detailed discuss of these risks.