Almost all new insurance products for the Russian commercial real estate market come from abroad. The reason for this is the large number of foreign investors in the Russian market. However, many types of insurance which Western companies would regard as standard are only now being provided by Russian insurers.
Insurance to Suit Everyone
The Russian construction boom and resultant growth in construction loans have created an increased demand for construction, property, and investment insurance products. One of the more positive trends identified by market experts is that clients are now interested in insuring themselves against a broad range of risks rather than just buying the mandatory insurance products.
“Along with the standard property damage insurance products, new types of coverage are becoming more popular, in particular insuring against lost profits resulting from commissioning delays and business interruption (BI) insurance, with various optional extras. This can insure the financial risks of both property owners and the construction firms they work closely with. Our company already has a substantial number of policies which include these new types of coverage. Insurers understand that an interruption to business activities and commissioning delays can result in huge losses. Our company not only compensates material damage but also financial losses in the form of lost profits which the insuree would have received,” says Anzor Bairamkulov, head of the real estate insurance department at ACE Insurance Company.
There is particularly high demand for lost profit insurance during the construction and operation of office and retail real estate. There are also optional extras which offer coverage against business interruption for specific segments of the commercial real estate market, like hotels, shopping centers and entertainment complexes (suppliers, restricted access, loss of desirability, damage to accounting records, sudden illness, or even actions of state authorities, etc.)
According to insurance experts, all types of insurance products relating to lost profits are complex because assessing lost profits is based upon the financial statements of the insuree and there exists the risk that the compensation will be greater than the profits which could have been earned.
Design errors are another key risk for commercial real estate projects. The collapse of a building could potentially not only result in huge losses for the owners but also do harm to third parties, including shoppers, tenants, and visitors. According to Yuri Guschin, managing director of Renaissance-Insurance, “This type of risk is very complex to assess and requires a high degree of knowledge on the part of the insurer. The popularity of insuring against design errors also is increasing. Russian developers have in the past underestimated this type of risk and excluded it from their insurance programs. However recent unfortunate events like Transvaal and the Baumanski market have made it clear just how important these types of insurance are.”
Following the collapse of the Transvaal Aqua Park, the construction firm, ETS, lost over 175 million roubles. The park was insured by ROSNO and Rosgosstrakh, but both firms refused to pay out, since the insurance policies did not include damages resulting from design errors.
There is also increasing demand for liability insurance from general contractors, owners, and tenants. Marina Shalneva, deputy director of the property insurance department at SAK Energogarant, comments, “There is an increasing demand for integrated insurance policies with broad coverage, including a large range of investment risks. They provide investors with the maximum possible level of protection against all possible losses - including construction works. Commercial Multi Peril insurance (CMP) insures post-warrantee obligations, construction-site equipment, construction materials, third-party civil liability, and transportation. Of course concluding this type of insurance agreement is a big task. It requires a considerable amount of time and assistance from qualified specialists but its level of integration makes it good for both insurers and investors.”
There are now specialized insurance products aimed at real estate management firms, which provide third-party civil liability insurance to protect them against the risks associated with the functioning of building services systems, equipment, and lifts.
Sometimes Russian insurance firms also provide consultancy services. Some sites cannot be insured in their current state or their insurance value is lower than the owners require. In such cases, insurance firms can make recommendations regarding improving the security of construction sites and installing alarms. According to Mr Guschin, management risk insurance is good for both parties. It lowers the risk of a large payout for insurance firms and also has a positive impact on overall claim statistics. At the same time the insuree receives a professional consultation about how to optimize risk levels which can lower insurance premiums since rates are calculated based upon preventative measures taken by the client.”
This approach is widely adopted in the West and is now in use in Russia, particularly for large industrial buildings. It has made less of an inroad into the commercial real estate market because the bulk of firms are still not willing to incur additional expenditure by implementing the recommendations of insurance firms, particularly relating to fire safety.
Experts comment that all the new types of coverage and additions which have appeared in Russia over the last few years were developed over many years by the international insurance market, where they are both highly recommended and popular.
The specifics of the Russian business environment mean that some products for which there would be a high demand cannot be offered by Russian insurers, mainly includingvarious types of financial risk insurance. The problem lies in imperfections in Russian legislation. The insurance market is regulated by the RF Civil Code and Tax Code in conjunction with laws: “Regarding the organization of insurance activities in Russia”, “Regarding joint-stock companies,” “Regarding bank and banking activities,” “Regarding bankruptcy,” “Regarding leasing,” and “Regarding the privatization of the housing fund in the Russian Federation.” Despite this impressive list there are no regulatory standards for insuring against financial risks and the Civil Code does not even include the concept of financial risk, only entrepreneurial risk.
These regulatory shortfalls are hindering the development of the Russian insurance market. “For example, contractual obligations can only be insured when this is sanctioned by a specific legal provision,” says Mr Guschin.
“When it comes to third-party civil liability insurance for management companies, insurers need to walk a very fine line in order to stay within the confines of the existing legislation, which only permits the insurance of liability in the event of damage by third parties (non-contractual liability.) The insurance of contractual liability is only possible when permitted by legislation, which today is not the case. This means that insuring the obligations of service organizations against the breach of the terms and conditions of contracts has no legislative basis. In spite of this, many insurers conclude such agreements with far-reaching consequences for both parties,” says Shalneva.
And that is not the only problem with liability insurance. While property insurance and mandatory types of insurance can reduce corporate tax liability, liability insurance does not lose its appeal.
Today there is a lot of competition in the insurance market, and experts predict that it will increase further. Unlike their Western counterparts, Russian insurers cannot patent new insurance services and form a monopoly in specific areas of insurance. Currently all new types of coverage and additions are simply licensed by the Federal Insurance Supervisory Authority of the RF Ministry of Finance, according to a procedure defined in legislation. Since insurance offerings are in the public domain, new developments are quickly adopted by competitors and everyone is used to this,” says Shalneva. In actual fact, the copying of competitors’ ideas is having a positive impact on overall market development because companies trying to become market leaders are forced to launch more and more new products.”
High competition levels in the insurance market are also producing negative trends, like cost undercutting and companies insuring all kinds of sites for minimal premiums even without a proper risk assessment. This approach will cause serious harm to the entire industry and reduce trust on the part of investors.
Having said all this, the main factor hindering the development of new services is a basic lack of demand, particularly from Russian companies. Foreign firms and those with a substantial share of foreign capital take out non-mandatory insurance but many Russian firms are still afraid of overpaying insurers. “The bulk of commercial real estate insurance products sold to Russian firms include: property insurance, civil liability insurance for the tenants of office buildings and large business centers, which the are mandatory requirement of lease agreements and of the insurance agreements concluded for the obtaining of loans. There is interest in new products on the whole, but demand is growing far slower than for more traditional products.
All the experts we questioned rated the growth prospects for commercial real estate insurance as excellent. The development of the national economy is producing high demand for insurance services. Mr Guschin comments, “Today specialized, advanced products have been developed for key types of commercial real estate, including hotels, restaurants, pharmacies, retail enterprises, and warehouses.”
Aside from the construction boom, another positive factor for the development of the commercial real estate insurance market is the taxation legislation which makes it possible for firms to reduce their tax liability via the payment of insurance premiums for construction and property insurance.
According to specialists from Renaissance Insurance, the greatest demand for insurance products is coming from developers.
The growth rate for charges for construction risk insurance in the Central Region is provided below:
- 2002 – 142%
- 2003 – 250%
- 2004 – 150%
- 2005– 110%
- 2006 – 125% (forecast)
- 2007 – 135% (forecast)
“Reduced growth rates in 2005 can be explained by reduced turn over in the construction industry. In the near future we forecast growth in demand for liability insurance and for insurance against design errors and post-warranty insurance,” says Mr Guschin.
According to Anzor Bairamkulov, the development of the commercial real estate insurance market seems assured. Growth of insurance charges remains at 20-30% per year and the role of banks insuring mortgaged property should not be underestimated. The share of mortgaged real estate in the portfolios of some insurers is as high as 70-80%. Experts predict an imminent increase in demand for liability insurance, insurance against design errors, and post-warranty insurance.