Battalions of Sorrows: Part 1, Insurance 

When sorrows come, they come not single spies
But in battalions.   – Shakespeare, Hamlet

Inflation is not a single force but a swarm of costs that appears in scouts and attacks from all directions. Though few of them will admit it publicly, many affordable housing owners and managers are under siege due to the still-rising inflationary aftermath of the policy reactions and responses put in place during the COVID Summer of 2020 – starting with the first and in many ways most disruptive: insurance.

As a suite of financial products, insurance operates like mortgage lending except viewed through a Christopher-Nolan-esque time-reversal machine. While the bank pays out a lump sum upfront and recoups payments over many years, the insurer receives regular payments before the capital event and pays out its huge lump sum after the event. That temporal reversal of capital flows also reverses the nature of the interest-rate risks being taken by the respective parties. When a borrower takes out a fixed-rate loan, it is betting that rates will rise by more than the yield curve implies; the lender is betting they won’t. When an insurance company issues a policy, it is betting that it can earn more on the premiums than the rate of inflation, and the customer is betting the insurer can’t. 

Beyond the odd macro-finance dynamics of this lies a moral hazard. In purely financial terms, the policyholder is betting that something specific and bad (in the jargon, a ‘covered event’) will happen to me within a discrete period; the insurer is betting it won’t. As a result, in good economic times, especially when there are low interest rates and underwriters with short memories, insurance gets progressively cheaper per quantum of risk: policyholders take this for granted as a reward for their managerial sagacity, prudence and skill. But when the cost of the insurer’s eventual future payout depends on the policyholder’s judgments and actions, the moral hazard flows the ‘wrong way.’ In fiction, this leads to great noir movie plots, but in the real world, it means that insurers abruptly raise rates only after the recent past has led to many wrecks.

Worse, when that unexpected event is brand-new, chaotically disruptive and widespread (as COVID was), and when the policy responses are hastily implemented, economically shortsighted and naïve (as COVID’s were), the nasty side effects can linger long after the disease itself is cured.  This has meant massive spikes in insurance rates. 

Although property, casualty and liability insurance rates for affordable properties vary widely by location (anything in the hurricane bowling alley from Florida to Texas tops the list) and construction types (hint: wood-frame is bad), across the board the rates are up. A year ago, the National Multi Housing Council reported a 26 percent average one-year boost, NDP Analytics’ October 2023 report Increased Insurance Costs for Affordable Housing Providers reported 83 percent of respondents experiencing double-digit rises averaging over 20 percent. Last month, a Shelterforce article cited hair-raising anecdotes or even higher rates – or even, in some submarkets and for some vulnerable property types, carriers pulling out of a state, submarket or property type entirely. Between them, Yardi Matrix (a real go-to resource with a library of high-quality free publications) and RealPage observed that, as of January 2024, insurance premiums were eating up more than 15 percent of the total operating budget everywhere in Hurricane Alley, with clustering around 30 percent year-over-year and up to 60 percent higher in, you guessed it, Florida.

Beyond the price jumps, shrinkflation has come to the product itself. Deductibles are way up (61 percent of NMHC respondents), covered events are being narrowed (57 percent of respondents) and coverage caps have been lowered (34 percent). Nor will these conditions reverse any time soon: reinsurance, without which insurance itself grinds to a halt, has likewise become much more expensive after getting hit with concentration-risk catastrophic losses and shows no signs of becoming cheaper.

All this hits affordable housing harder than conventional properties, for two rent-related reasons:

1. Less NOI cushion. Whereas conventional properties have classical operating expenses ranging from 38 percent of rents (San Diego) to 50 percent of rents (Houston), in affordable housing the range is from 45 percent (Orlando) to 70 percent (Indianapolis, Kansas City, Philadelphia). 
2. Lower rent-increase resilience. Rents are capped by external factors, such as Area Median Income (Low Income Housing Tax Credits), Section 8 fair market rents (or OCAFs, which also lag reality) or additional deep-affordability restrictions negotiated to win Qualified Allocation Plan points in happier times.

Belts are being tightened. NDP Analytics reported that, among the 93 percent of owners trimming budgets, they are increasing insurance deductibles (67 percent) and reducing coverage (46 percent). Beyond insurance, they are also “decreasing or postponing investments (52 percent), decreasing other operating expenses (64 percent)—How, pray tell?—and reducing employment or holding off on new hiring (20 percent).

None of which will work for long, and the temporary relief may be worse – especially as nothing suggests that insurance premiums will stop rising.  As Fannie Mae put it, “Inflation has compounded costs as replacement and repair costs rise. Multifamily insurance premiums reflect these record costs.”

And insurance is just one of the costly winds swirling. In the next Guru, I intend to cover staff costs and turnover, maintenance, vacancy – and concessions, where there have been outbreaks of non-payment epidemics resulting from the confluence of good intentions too hastily deployed.