Insurance Considerations that Benefit the Landlord-Tenant Relationship

Property owners and tenants have recently come together in Singapore to bring changes to the Code of Conduct for fairer lease negotiations. Although legislation has yet to be passed, and the agreements need to be “road-tested”, this is a timely reminder that the solutions to the challenges faced need not be mutually exclusive between owners and occupiers.

Across the region, both Real Estate tenants and property owners are under intense financial strain, but any drive for efficiencies need not translate into greater risk exposures. Thus, in this article, I will address how this can be done by taking a fresh look at the basics that underpin risk management and introducing some innovative features that may facilitate risk transfer.

Back to Basics: An Insurance Review

A good starting point is also the most obvious one — to review insurance inputs for accuracy and adequacy. Two examples should elaborate on and illustrate this point:

Firstly, property owners should consider the replacement costs of their assets, rather than their market values, and update their valuations. Insurers will apply average clauses for an underinsured property, hence, in the event of a loss, the property owner will suffer financially due to proportionally lower claims payments. It should be noted, however, that a valuation update need not necessarily lead to a higher replacement value. In some instances, owners may find they have an over-insured property based on inaccurate valuations, incurring needlessly higher premiums, particularly where land costs represent a higher percentage of the overall cost of a property.

Secondly, a consideration for tenants in Asia is their lack of a waiver of a right of subrogation in the owner’s property insurance. This right of subrogation legally allows an insurer to pursue a third party that caused an insurance loss to the insured to recover the amount of the claim paid to the insured. In Asia, a waiver is not normally granted to the tenant, as opposed to the norm in the US and the UK. As such, a tenant is exposed to a small but financially significant risk in the event of damage to third-party property. Additional limits can be sought to transfer this risk, also ensuring compliance with global corporate standards for multinational organizations.

Therefore, reviewing insurance inputs will identify the gaps or excesses in coverage, enabling the property owner to optimize their risk transfer to an accurate amount.

A More Efficient Approach

Insurance clauses within tenancy agreements offer another opportunity for improvement. The limits required by a property owner are often set according to bands based on the occupied areas. There is a degree of arbitrariness to this practice, but a risk advisor may fine-tune this assessment to ensure: 

(i) the owner’s interests are adequately covered, and

(ii) tenants achieve greater cost efficiency of their premiums.

Moreover, different tenants will get insurance from different insurers, each with different policy wordings. In the event of a loss, all these policies will respond with varying degrees of efficiency and effectiveness. Collectively, the tenants’ insurance programs can be set up by a risk advisor so that property owners’ interests are adequately covered, losses are more easily managed, and reinstatement is optimized. These tenants may also achieve economies of scale and benefit through improved pricing and policy conditions.

More Innovative Uses of Insurance Capital

Many insurers currently have reduced risk appetites partly due to losses suffered over consecutive years and the challenges they have faced from the pandemic.

However, this will change when the outlook becomes clearer, which will enable more innovative approaches to deploying insurance capital in Real Estate. For example, under the right conditions, supported by meaningful data, insurers will have the appetite to underwrite tenancy default risks.

Furthermore, with the abovementioned favourable conditions, financing mechanisms can be created to substitute lease deposits, releasing capital for tenants without affecting the security offered to a property owner.

Conclusion

Plato wrote: “Our need will be the great creator”. Real Estate and Risk Management’s current difficulties have brought into keener focus the importance of accurate data and the need for a fresh approach to solving problems.

This focus will bring about a greater understanding among all parties as they are driven by their need to adequately manage risk in a cost-efficient manner and use innovations that go beyond the traditional role of insurance to delve deeper into Real Estate operations.

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Edward Farrelly

Senior Vice President, Asia Real Estate Industry Lead