Commercial Real Estate

Management companies are inevitable impacted by the risk of property damage and thirdparty personal injury claims. Specialists are unanimous in their view that management companies must take out civil liability insurance.

The Case for Insurance

“The most important type of insurance service purchased by property management companies is civil liability insurance. It insures the company and any organization it hires against civil personal injury suits by third parties i.e. tenants and visitors, explains Mikhail Alexeev, head of property insurance and liability at Kapital Insurance.

In theory any serious error or oversight in the managing of real estate can have very serious consequences that can result in management companies being put out of business. By taking out civil liability insurance, which has very low premiums in comparison with the amount of potential losses, management companies’ financial risks can be significantly reduced. In the event of a claim the cost burden is simply passed on to the insurer. Insurance experts comment that policies offer management companies a kind of guarantee of financial stability. “A welldrafted insurance policy protects the management company from unforeseen losses and also makes the company more effective. At the same time building owners don’t have to worry about whether the management company would be capable of paying compensation in the event of a serious problem. It should be noted that the current increase in the number of claims in this segment only further confirms the importance of taking out insurance,” comments Tatiana Lavrova, head of management insurance and liability at Ingosstrakh.

In addition to civil liability insurance, management companies often take out property insurance for the buildings they manage, which covers them against the risk of fire, damage, flooding and other forcemajeure scenarios. This area is somewhat controversial – after all why should management companies insure buildings that they do not own? In theory, it is owners who should insure their assets; however, in practice, this function is often undertaken by management companies.

Risks

Sometimes the responsibilities of management companies also include working with subcontractors, which can be something of a minefield. Instances of massfood poisoning, people falling into lift shafts and cables being damaged during repair work may not be daily occurrences but they do take place on a relatively regular basis. In order to ascertain which risks should be insured against, everyone involved must be closely questioned. “Ideally you should insure against all possible risks involved in the management and servicing of real estate. As a professional management company our task is not only to insure our own interests but also losses that could potentially be incurred by our clients and maximize protection against all financial risks,” says Boris Avksentiev, managing director of real estate management at Cushman & Wakefield Stiles & Riabokobylko.

Market experts identify a whole series of risks associated with real estate management. These include risks related to the operation of car parks, fastfood outlets, restaurants, cafes and bars. Another block of risks relates to the functioning and maintenance of building service infrastructure and equipment such as shutdowns, fires, leaks, broken pipes, flooding etc. Particular attention needs to be paid to cleaning services. The cleaning products in use today can be potentially dangerous. There are also risks associated with facade constructions and industrial climbing. “There is a very serious danger posed by icicles falling from rooftops and roofs can be damaged by piledup snow. This concerns management companies because normally they are responsible for removing snow and icicles,” says Ms Lavrova.

According to Mr. Alexeev, recently there has been an increase in the number of claims by third parties both individuals and corporations, against service sector companies including management companies. “More often than not such claims are supported by the courts when they are reasonable and based on the regulations provided in the acting legislation,” says Mr. Alexeev.

Insurance claims

So what kinds of payouts are envisaged in the standard insurance policy? In the event of the complete loss of property the insurance payment can equal its real value at the time the policy was issued, minus whatever funds can be raised from its sale or further use. But this amount cannot exceed that stated in the insurance policy.

In the event of partial property damage the insurance payment should be sufficient cover the property being returned to the condition it was in prior to the event. It should be pointed out that that the insurance amount required for restoring the property to its original condition cannot exceed its overall real cost.

In the event of injury or illness insurance policies cover loss of earnings and any additional expenditure required for returning the individual to good health including special diets, therapies and medical expenses.

Insurance policies also cover the cost of court cases, lawyer’s fees, the hiring of independent experts and any other expenses required for establishing the client’s degree of liability. It should be borne in mind that for most companies there is a cap on the cover for legal fees

Lost profits

The mistakes of management companies can also potentially prevent tenants from carrying on their business activities for example, if the water supply system fails because of an accident or a maintenance error results in the computer servers for a bank or online stock exchange going down. In such cases the potential losses can run into millions.

If this happens is the management company liable and can you insure yourself against the lost profits of third parties? “Many companies offer profit loss insurance however this cover is strictly capped and payments are only made on the basis of court decisions,” says Alexander Poludeny, head of the development center for insurance of large business at ROSNO. “This type of insurance should only be understood as an additional rather than the key clause of an agreement. Management companies can be liable within the established limits; however, constantly offloading liability onto their shoulders is not entirely correct,” he adds.

By way of illustration experts use the following example: the profits generated by a stock exchange cannot be compared to the income received by a management company. So why should management companies insure against the lost profits of stock exchanges? According to experts under this scenario the stock market should be responsible for protecting its own interests by insuring against financial risks. “The lost profits of building owners represent an indirect loss. Under most insurance rules such losses are excluded from cover. They can be insured as a financial risk however in the Russian insurance market this type of insurance has not as yet come to the fore,” says Mr. Avksentiev.

You can also insure against claims for emotional pain and suffering; however, this type of insurance is not particularly relevant to Russia since the courts are not sufficiently experienced in dealing with these kinds of cases and compensation payments are likely to be very small. Again such payments would only be made on the basis of a court decision and be within specified limits.

Insurance agreements can also include court costs as part of the overall insurance amount. A number of insurance companies include the risk of damage resulting from repairs, finishing work and renovations.

An extension of the time limit for filing claims beyond the end of the term of the contract can also be included as an additional clause. Interestingly, during the renewal of an insurance agreement you can introduce a retroactive date specifically relating to the extension of the claims period in the case of an insurance event.

Insuring subcontractors

Insurance companies also offer another service – insuring the liabilities of subcontractors, i.e., cleaning and catering services, etc. This begs the question why should management companies be responsible for subcontractors who should presumably be insuring themselves against thirdparty claims? “It is simply easier to include a subcontractor liability clause in your policy than to supervise and coordinate the insurance documentation of every subcontractor you hire,” believes Eduard Apsit, chairman of FACILICOM. Mr. Poludeny comments: “It is the management company who is responsible for all work inside the building and on the adjoining territory including outsourcing. Even if the damage has occurred as a result of the actions of a subcontractor there is no guarantee that the management company will not ultimately be held liable for any thirdparty claims. And so all subcontractor liabilities can in theory be incorporated into a single insurance policy and insurance amount, which ultimately makes it cheaper for everyone.”

Many companies don’t include subcontractor liability in their policies on the basis that these companies should be insuring themselves. This requirement is now increasingly being reflected in subcontractor tenders.

Integrated insurance

Nowadays insurance companies offer integrated insurance programs that provide one policy that covers the liabilities of owners, management companies and tenants with a single liability limit. “Integrated programs offer considerably reduced risks for management companies and significantly streamline the mechanism for protecting against losses,” believes Mr. Alexeev. However, since these programs have only just emerged on the market, none of the endusers we contacted were able to give an evaluation of their pluses and minuses. “These kinds of policies could well experience high demand and it is the job of insurance companies to inform their clients about them,” comments Konstantin Baranov, partner at Colliers International FM.

Affiliated organizations

If a building is managed by an affiliate of the owner then the liability of the owner, its affiliate and the management company can be covered by one policy. However, there have been instances where the affiliate organization has shown an interest in taking out insurance.

Liability limits

The exact amount of civil liability insurance is decided by the two sides. Since it is impossible for a management company to estimate the potential losses from a thirdparty claim it is up to insurance companies to establish the liability limit, i.e., maximum possible damages. As you would expect this limit depends on a number of factors. “Taken into account are things like the volume of work, complexity of the site, level of qualification and experience of the service personnel and history of losses etc.,” says Natalia Karpova, deputy general director of Renaissance Insurance.

In general, insurance companies offer the following terms for issuing annual civil liability insurance: a liability limit of $500,000 with a $1,000 deductible (i.e., amount which the company is obliged to pay in the event of claim) at a cost of $2,700. For a $1million limit this increases to $4,500, and for a $5million limit the corresponding cost of the policy would be $6,500.

Why are liability limits lower in Russia?

The specific nature of Russian business is reflected in the insurance market. In comparison with the West, the insurance amounts for management companies are several times lower. However according to market experts this is not the result of the relative youth of the property management sector or a desire on the part of insurers to save money. “In Russia, despite its high­profile, property management is a fairly small sector. Consequently the risks associated with their work are smaller than for their Western colleagues,” says Mr. Baranov.

“So then why are limits so high in the West?” Rhetorically muses Mr. Poludeny. “Because lawsuit claims for thirdparty injury and illness are gigantic. In Russia the cost of a human life is not very high in insurance terms. Fortunately, however, this is gradually changing.”

Market volume

At present it is impossible to evaluate the volume of insurance in the sector. The very detailed research required to ascertain this has not been carried out because the market is simply too young. Moreover the insurance business is not predisposed towards openness and companies are often unwilling to provide details of their terms to their competitors. Our humble attempt at analyzing the situation has led us to an unsurprising conclusion – not all companies take out insurance; however, managing a large important asset without any insurance is today no longer possible. “For the most part, our company works with foreign clients who regard insurance policies as a mandatory condition,” says Sergei Surzhin, legal consultant at M+W Zander. “Not all Russian management companies can boast the same. However if they wish in the future to broaden their sphere of influence they will have to insure their civil liability.”

More often than not owners require at the tender stage that management companies are fully insured. “At the same time a lot of companies have independently come to the conclusion that they need to take out insurance,” says Mr. Poludeny. “These are the kinds of companies who have been for around for a while and value their image and reputation. Many of them have already encountered difficulties in the past and for them the need for insurance is no longer a theoretical notion but a formal requirement,” adds Mr. Poludeny. “In my view it is quite common for management companies to take out civil liability insurance. In this regard Russian companies are much like their western counterparts. It should be remembered that today more and more contracts signed between management companies and real estate owners include detailed liabilities. This only further facilitates the insurance of the risks facing management companies,” believes Mr. Avksentiev.

Market experts point to a trend that is slowing down the development of insurance products for management companies. There have been instances in which management companies have only been able to work with building owners for a couple of years, because when all the systems were up and running they were let go. In these cases the owners’ rationale was: if everything is working so well why pay for outsourcing? They then set up their own structures often by hiring specialists from their former management company as well as from affiliated organizations and show no particular desire to take out insurance.

According to Ms. Karpova, the absence of the practice of using insurance to minimize risk and a reluctance to take on insurance costs is having a negative impact on the industry’s development.

According to a number of important market players insurers and insurees are only now starting to work together more successfully. “All the different participants need to be very professional in their approach: insurance companies, their clients and real estate owners,” believes Mr. Apsit. “Management companies have reached the point where they really need to insure themselves. However at present there is a shortage of highquality products on the market. Agreements are sometimes poorlydrafted and not standardized and there are poor levels of competition between insurance companies. As for management companies however, in order for them to calculate the earning power of their businesses they must insure themselves against financial losses. Only then can they look to the future with confidence,” concludes Mr. Apsit.