Condos: A Difficult Market to Navigate

The condominium building is an interesting form of owning property where an individual owns their unit, what is sometimes referred to as a box of air, and at the same time, becomes a part of the condominium ownership association, which owns the real property. In essence, one becomes a shareholder and stakeholder in the larger organization simply by owning the place where they live.

It’s a bit more complicated than that because there are residential condominiums that are owned as long-term rental units, others that are owned as short-term rental units, and others that are non-residential units. For this discussion, let’s stick to the residential units in residential buildings. These are the condos that many of us think about when we think about this topic.

We are hearing from many around the insurance industry that condominium buildings are getting harder to insure. The terms are getting restrictive. The underwriting requirements are getting harder to deal with, and the price is getting very high. So, what’s going on?

A Hard Market

This is a classic hard market problem, but there is more going on.

Let’s just start with the simplest, most direct answer. As this is being written, we are in the middle of a hard market. The primary characteristics of hard markets are that prices are high, underwriting is tight, and companies shy away from certain types of insureds.

When insurance companies see their profitability and policyholders’ surplus begin to diminish, they are going to take certain steps to ensure that they continue in business. Every dollar that an insurance company brings in can be set into different categories of expenses on the other side of the balance sheet. Some money is spent on operations, which is the same as every other business in the world. Insurance companies also have to make a profit because that’s one of the biggest reasons a person or organization enters into business. But there’s more to it than that.

Money for Claims

Carriers must account for the claims that the insurance company knows about and reserve money to pay them. Every time a claim is reported, the company needs to determine how much money the claim could be worth and set that money aside. Insurance companies also have to set aside money for the potential future claims that may come.

Insurance companies need access to money because of the risks that they accept. Each policy represents the potential for a claim for the limits of that policy. That’s part of why each state requires that an insurance company maintain policyholders’ surplus. This is money that isn’t earmarked for a reported claim, daily operations of the company, profit or some other purpose. It’s set aside in case the insurance company can’t cashflow claims with current premium payments or other sources of money.

Combined Ratios and Inflation

In recent years, insurance companies’ combined ratios have exceeded 100%, meaning that the company was paying out more than they were bringing in through premiums. That was fine for a while because the companies had investments that could make up the difference so that they were still making a profit.

When inflation hit and hit and hit, those investments began to bring in reduced investment income, making those ratios harder to sustain. That’s a simplified look at one of the causes of a hard market, and poor economic conditions, which in the end means that insurance companies have started to protect themselves by writing fewer risks, charging more for the risks that they are writing, and restricting coverage through policy changes.

Aging Condominium Buildings

Those general market conditions don’t tell the whole story. The condominium as a way of owning property is about 60 years old in the United States. The first condominium laws went into effect in Puerto Rico and Hawaii in 1958. Ever since then, condominium buildings have been built in cities all over the United States.

Many of those buildings were built in the 1960s, ’70s, and ’80s. This puts those buildings at 40 years old and up, which means that they were constructed according to the building codes in effect when they were built.

Buildings are just like everything else in the world around us. They need maintenance, upgrades and changes. In 2021, a portion of the Champlain Towers South building in Surfside, Florida, collapsed in the middle of the night. That building was completed in 1981. Investigators determined that the building collapse was caused by deferred maintenance. Deferred maintenance issues are caused when someone is aware of a problem with a building but for some reason, the problem isn’t fixed right away.

In your house, it would be like that time when you discovered a leak under a bathroom sink, but since no one uses that bathroom, you just shut the water off and said to yourself that you’ll fix that when you have time later. The sink’s leaked for the last decade. That’s deferred maintenance.

Condominium associations will struggle with these maintenance and upgrade issues because the association has one primary source of income, the association fees that are charged to unit owners. If those fees are not raised appropriately to meet the financial needs of the organization, then they have to choose how to spend the money that they have, and they have to determine how they are going to raise enough money for any additional budget items, like significant maintenance.

Condominium Association Boards

Condominium associations are run by elected boards. These boards are made up of unit owners who seek election to the board and they serve according to the by-laws of the association. The fact that these boards are comprised of volunteers who run for election for any number of reasons and with any number of backgrounds means that the board can sometimes be difficult.

Let’s go back to the deferred maintenance issue and say for example that a resident noticed something off in an underground parking structure so the board votes and approves hiring a structural engineer to investigate. The engineer returns with a report that includes a recommendation. She recommends that the association make significant repairs, making the parking garage unusable for a minimum of one year.

The board then has to decide how it will vote to proceed, knowing that residents will not be happy about not having their parking spot, nor will they be happy about the cost of this repair work. Maybe they ask the engineer for some options for temporary repairs, or incremental repairs that will minimize the disruption to the residents. Maybe the board will pay the cost to bring another engineer in for a second opinion and start the process over.

In the meantime, the inspections, reports and deliberations happen over several months of board meetings. Maybe the board can’t take action because they have a hard time getting the required quorum in the summer. After all, people take vacations. Then board member elections come up again and some new board members cycle off the board and new members join.

The board has to elect a new president. So, after all that, the new board needs to come up to speed on all of the board business that has been pending, including getting their insurance renewal quotes from their insurance companies.

Insurer Actions and Concerns

Add to this that the board may not have any people who understand their insurance needs, the insurance process, or why the insurance company keeps demanding that they take the electrical boxes out of residents’ closets. If we change our scenario a little so that instead of a resident discovering a potential problem and the board hiring an engineer, the insurance company sends an inspector out to look around, take pictures, and check on the building while underwriting the renewal.

When the insurance company sends a field underwriter out to look at the building, the field underwriter will send a report back to the company and three things are likely to happen if there are any issues at all with the building, since the building is potentially the largest exposure that the association has.

The insurance company could offer to renew the policy with a significant premium increase. This is hard for the association to swallow, but it’s the easiest option to deal with.

The insurer could offer to renew the policy with a less significant premium increase and with significant coverage changes. This may be easier to deal with for the association because the price tag is higher but lower than it could be. They could talk themselves into the reduced coverage in several ways, including thinking that a loss isn’t that likely, is it?

The insurance company could simply non-renew the policy because of the conditions that they found on inspection. This is one of the worst cases for the insured because then they will have to go through the process of looking for other companies to write the insurance and many of them will start asking questions, which will need answers.

It’s also possible that the insurance company provides a conditional renewal on the condition that certain repairs get made within a specific time. That’s a difficult option for the association because then they have to do something about the expensive repairs quickly or go looking for other insurance, which will easily be more expensive than the current company.

In the end, this segment of the insurance market is very difficult to navigate and there are no simple answers.