Since the September 11, 2001 attacks, insurance has been one of the most talked-about topics within the hard-hit hotel industry. Overall, insurance costs have been drastically increasing during the last three years. In the midst of all this, hoteliers are faced with the challenge of securing and affording adequate insurance coverage within the guidelines of their loan documents.
Hotel Insurance 101: Back to the basics. Before we go into more detail on this topic, let's take a brief look at what the typical insurance cost line item entails. There are several kinds of insurance coverage, but for the purpose of this article we will focus on the three major types: property, casualty (general liability), and worker's compensation.
Property Coverage – The property coverage refers to the actual "sticks and bricks" of a hotel. The amount of coverage is determined by the construction quality and the underlying value of the building. Another important premium-determining factor is the geographic location of the property. If the property is located in a geographic area exposed to catastrophic loss (any type of natural disasters, i.e., floods, earthquakes), the property coverage premium is adjusted upwards accordingly. In the case of a hotel portfolio, the percentage of the properties which are exposed to catastrophic loss can make a significant difference in the overall premium paid for the portfolio. Thus, it is an important factor to be considered before the acquisition of a property. Items covered include business interruption, equipment such as boilers and machinery, builder's risk (in the case of a new hotel), and any type of improvements, i.e., golf courses or landscaping.
Casualty (Liability) and Umbrella Coverage – The casualty (general liability) coverage refers to third- party liability and accidents that occur within the hotel's premises. The coverage is usually determined on a room-count basis and the market segment that the property belongs to. Some of the items covered by the casualty component include general liability (slips and falls), professional liability (masseurs, personal trainers), product and liquor liability, valet parking, and physical damage liability. In addition to primary casualty coverage, it is a common practice for hoteliers to obtain umbrella liability coverage. The purpose of this coverage is to limit the exposure of the hotel in cases where damages are higher than the amount offered by the primary casualty coverage.
Worker's Compensation – The work comp (as it is called in the industry jargon) refers to the statutes that provide fixed awards and medical reimbursement to employees and their dependents for employment-related injuries and illnesses. It is regulated by the state, and it is strictly driven by payroll and class code of the position (i.e., F&B, Rooms, Accounting, etc.).
One way to control hotel insurance cost is by utilizing a captive insurance company. A captive insurance company is an insurance company that has been set up to provide coverage at a lower cost than what is available by going through the general insurance market. The company's stock is controlled by one interest or a group of related interests so as to provide coverage for their business operations. A captive insurance company may be a non-admitted, a non-resident, or a foreign insurer. Sometimes it may provide reinsurance to a self-insure or a domestic company. "Size is a critical factor in the decision whether to use a captive insurance company or not," according to Mr. Tony Rodolakis, Vice President of Risk Management, Starwood Hotels & Resorts. Mr. Rodolakis continued, "Some of the main advantages are that it offers direct access to the reinsurance marketplace and it is a very efficient way of funding risk in terms of capturing all cost elements of a program." Ms. Nermine Demopoulos, Insurance/Risk Management for Marriott International, adds, "It offers certain tax benefits a certain degree of flexibility, which is particularly necessary in today's markets."
The September 11, 2001 attacks brought to the surface an insurance coverage type that historically had been neglected: the terrorism risk. According to the Merrill Lynch Property/Casualty Weekly Review, the September 11 attacks will cost the insurance industry between $50 and $70 billion. Due to the substantial losses incurred by the insurance industry and the increased possibility of similar types of terrorist acts, on November 26, 2002, the federal government signed into law the Terrorism Risk Insurance Act 2002, known as TRIA. What is TRIA all about? TRIA establishes a temporary Terrorism Insurance Program by which the federal government shares the risk of loss from foreign terrorism. The Act requires all commercial property and casualty insurance companies to offer foreign terrorism coverage and provides a federally funded backstop for insurance companies in the event losses from such acts exceed a certain amount. This federal program will terminate on December 31, 2005. By June, 2005, the Secretary of the Treasury will submit a report to Congress regarding the capacity of the property and casualty insurance coverage to offer affordable terrorism insurance coverage after the federal backstop expires. Under the Act, the government would step in on any claims above $5 million. Insurance companies would pay a deductible of 7.0% of the premiums received in the previous year. The deductible would then rise to 10.0% in 2004 and 15.0% in 2005. The federal government would in turn cover 90% of everything above the deductible, with the insurance companies paying the other 10.0%. Federal payments would be capped at $90 billion the first year, $85 billion the second year and $85 billion in the final year of the program. (For more information about TRIA, please refer to www.ustreas.gov.)
But how does TRIA affect the hotel industry? The opinions on this topic vary, with some hoteliers agreeing that TRIA has enforced some control on the terrorism insurance premiums, while others believe that it has done very little or nothing to resolve the problem. Terrorism coverage is offered by insurance companies either as a stand-alone coverage or it can be applied to each of the three major insurance components. "It is solely driven by how "hot" (the potential of a terrorism act occurring in a particular location) a location is considered to be and coverage can range anywhere from 0% to 40% of the premiums," according to Mr. Tom Cleary, Vice President, Hospitality, of Acordia, an insurance brokerage firm. Since September 11, lenders, despite the fact that in some cases the coverage becomes unaffordable for the hotelier, require terrorism risk coverage. Mr. Cleary continues, "There have been cases where insurance companies quoted extremely high premiums for hot locations, and lenders backed off from a deal, due to the inability of the developer/hotelier to afford such a premium. As a result of these tremendous cost increases, hoteliers are encountering very high fees, postponing new development, or dropping terrorism coverage, thus risking a bank default and potentially substantial losses in case of another terrorist act."
What have been the historical fluctuations in each of the three major insurance cost components? According to Mr. Vijay Dandapani, Chief Operating Officer for NY-based Apple Core Hotels, property coverage premiums have increased by approximately 100%, from 2000 to 2002. Following that trend, the umbrella coverage premiums have increased by roughly 50% per year during the same period, according to Mr. Rodolakis. Both Mr. Dandapani and Mr. Rodolakis agreed that worker's comp premiums have increased by approximately 10% annually. Mr. Rodolakis added that casualty premiums have increased at a similar rate of roughly 10% annually.
How do all these increases translate into the profit and loss statements of a hotel? After reviewing a certain number of historical income and expense statements from both full- and limited-service hotels, we have compiled a composite for each category, which shows the historical insurance cost changes from 2000 to 2002.
Table - Historical Insurance Costs Increases, 2000 - 2002
As the preceding table indicates, the insurance cost for full-service hotels, on a percentage-of-revenue basis, increased from a range of 0.2% - 2.0% in 2000 to a range of 0.6% - 4.6% in 2002. This change reflects a range of 130% - 200% increase during the two-year period. For the limited-service hotels the equivalent range increases were from 0.2% - 2.2% in 2000 to 0.5% - 3.5% in 2002. This change amounts to a range of 59% - 150% increase during the two-year period.
On an amount-per-available-room (PAR) basis, the full-service category recorded an increase from a range of $124 - $699 in 2000, to a range of $343 - $1,351 in 2002. This change reflects a range of 93% - 177% increase during the two-year period For the limited-service category the equivalent range increases were from $60 - $447 per available room in 2000 to a range of $120 - $776 per available room in 2002. This change reflects a range of 74% - 100% increase during the two-year period.
On an amount-per-occupied-room (POR) basis, the full-service hotels recorded a range increase of $0.46 - $2.80 in 2000 to a range of $1.35 - $6.38 in 2002. This change reflects a range of 128% - 193% increase during the two-year period. For the limited-service hotels the equivalent range increases were from $0.23 - $2.60 in 2000 per occupied room to a range of $0.47 - $2.80 per occupied room in 2002. This change reflects a range of 12% - 104% increase during the two-year period.
It should be noted that in order to show the effect that a hot location has on the insurance cost, both categories include hotels that are located in relatively "secure" locations (i.e., a hotel in Little Rock, AK) as well as properties that are in locations considered to be hot (i.e., New York City, NY). Furthermore, the simultaneous decline in gross revenues and the increase in insurance premiums during the last three years have exacerbated the increase in rates (as seen in the three comparison categories) even further.
What are the predictions for property and terrorism insurance costs in 2003? According to Mr. Cleary, for large accounts ($1 million or more) with good loss rates, premiums are expected to stabilize or even decrease slightly. Mr. Rodolakis and Ms. Demopoulos share the same prediction, as they also agree that for large accounts such as Marriott International and Starwood, rates are expected to either remain flat or to decline slightly.
Mr. Cleary continues on to say that small to mid-size accounts ($1 million or less) with good loss rates, premiums are anticipated to either remain unchanged or record up to 30% increases. Of course, all of these predictions are based on several assumptions, with the most critical being a relatively short-lasting war, no more terrorist attacks, and a gradual economic recovery.
So, what can the hoteliers do in order to mitigate the exorbitant increases in the insurance premiums? There are some simple, but nevertheless useful actions to be taken.
1. Review and/or revise your safety and security manuals and procedures. Insurance companies value preventative risk management, thus, periodic meetings with your security director can help address any upcoming security/safety issues and will help you maintain up-to-date manuals and procedures.
2. As a large amount of insurance claims are derived from hotel guests, make sure that employees, both front- and back-of-the-house, are updated with any changes and are well-trained in case of an incident. The proper handling of an in-house incident by hotel staff can significantly reduce the amount of an insurance claim.
3. Do your "homework" when shopping for insurance coverage, by working with your insurance broker. An insurance broker can save you time and money by providing you with all the available insurance plans and by matching your insurance coverage needs to the right insurance plan. Be cognizant of the purchasing/negotiating power of your broker and look for specific expertise within the hospitality industry.
4. Present to your broker as detailed and complete a picture of your property as possible. The provision of detailed property and financial data, supplemented with historical insurance claims, will enable the insurance company to accurately assess your property. The better the submission created and sent to the insurance marketplace, the better the program that will be offered.
5. Raise your insurance premium deductible. By increasing your policy's deductible you alleviate some of the insurance company's risk, which in turn will translate into some reduction for your insurance premium.
6. If you cannot avoid it, you might as well prepare for it. After taking every action to reduce your premium, you should face the reality of the high increases and reflect it in your budget. A realistic estimate will give you the real, rather than the desired picture of your bottom line.
