We’ve shared many of these insurance thoughts before, but not all in the same place. Today, we’ll be staying out of the “weeds,” not because “there be snakes,” but we don’t want “detail” to drown out some basic messages.
Insurance is a credit enhancement. If you have a lot of money (think Exxon, Bill Gates, etc.), you can cover your own obligations, pay your own liabilities. You don’t need a sugar daddy back-up. And no one should require you to have one. A landlord who does an absolute-net lease of an entire $100 million building to Exxon, doesn’t need Exxon to buy property insurance from insurance companies. Exxon can buy the insurance companies. It can handle the loss. Its net worth is about $500 Billion. It has more than $50 billion of cash on hand. Chubb Insurance has equity of about $16 Billion. We would have said “only,” but that’s “only” when compared to Exxon.
Sure, that’s good for Exxon, Ford, Chevron, Pfizer, and you name ‘em, but what does that have to do with me?
The answer my friends, is “scale.” Let’s not knee jerk ourselves into asking solid tenants to carry tiny deductibles. Let’s think about it. If we are only asking our tenants to carry $2 million of liability insurance, why ask that of a solid company with lots of assets?
By the way, the reason we say “tenant,” and not “landlord,” is because most landlords today are single asset owners and, unlike with tenants, landlords rarely have a “guarantor” on the line.
Here’s another general thought about asking that a tenant carry insurance. Why do we do so? I what ways does a landlord benefit when its tenant carries insurance? As to a tenant’s coverage of its own personal property (inventory, store fixtures, etc.), the tenant, not the landlord, suffers the loss and gets the money When a landlord asks its tenant to insure its personal property against loss from an insurable peril, it is telling the tenant that it wants the tenant to be able to replace the lost property and get back into business at the leased premises. Yes, the landlord will benefit from that and that makes it a legitimate request BUT only if the tenant needs the insurance proceeds.
Posit a 300 store retail chain with its own distribution centers. Do you think it needs to insure a store’s inventory? You can bet your bottom dollar (not the old grocery chain) that replacement merchandise will come from a distribution center without scratching the surface of its inventory. It already owns replacement merchandise or has it readily available and committed from suppliers. The same is true with store fixtures. Is already has them or deals with store fixtures in the ordinary course of its business. So, why should such a retailer (regardless of size so long as it has proportionate abilities) want to carry insurance for its store’s personal property? If it can bear the loss without blinking, why should it have to fight with a landlord who thinks its form lease overcome logic?
That having been said, perhaps a landlord should insist that retailers of that nature insure their distribution centers. If anyone is going to have that conversation, can you record it for us? Has anyone ever seen a lease that required a tenant to carry insurance for risks not related to the leased premises? We haven’t and we don’t think we ever will. On the other hand, we’re pretty sure that almost all retailers insure their distribution center inventory, and if they don’t, they probably have no economic need to do so. And, that’s without even discussing deductibles or self-insured retention. [For an explanation of the differences between these two, click: HERE.]
Well, it’s all fine and good to focus on loss by a tenant of its personal property where the insurance proceeds aren’t going to go to the landlord. Perhaps we should say, “Shouldn’t be going to the landlord” because we see landlords insisting (in the first draft, at least) that they be loss payees on such policies. Well, landlords rarely have an insurable interest in that property and because the loss payee is only entitled to recover “as its interest may appear,” all the landlord ends up doing is interfering with the tenant getting right back into business.
What about the common landlord notion that it will obtain insurance for the building, but not for the “leasehold improvements,” and to insist that its tenant insure leasehold improvements? Well, we’ve ranted about that nonsense before. To quote ourselves: “Except in the most unique of circumstances, when the ash settles, you can’t tell what the landlord built or bought and what the tenant added or changed to a building. Suppose a tenant removed a wall. That “destruction” is a tenant leasehold “improvement.” It decreased the cost of rebuilding. How much coverage should a tenant carry for such a tenant leasehold improvement? OK, after you’ve stopped throwing things at me, forget removing a wall – let’s say “moving a wall.” Same question; same answer. Let’s replace the sinks, the lighting fixtures, and so on.” If that makes you curious about how Ruminations really feels, click: HERE. We would like to add this thought – “do you think the insurance company, when estimating the replacement cost of a building, knows which improvements were added by a tenant or which were replaced by a tenant? We don’t. We think the premium includes leasehold improvements. Certainly, there are special cases, but we prefer to ignore the flea when looking at the elephant.
How about the single-tenant building where the landlord insists that its tenant carries the property insurance? To Ruminations, that’s crazy. And it is just as crazy for a landlord to give into a tenant that insists on doing so (because it “can get the insurance ‘cheaper’”). If the tenant is responsible for the cost of restoring the building and can “just write a check,” then why bother about insurance. [Yes, we are pretending that the lender is as flexible in its thinking as we are.] If insurance is needed because, without it, the tenant can’t cover the tab, then the landlord should “control” the coverage. After all, if the tenant can’t belly up to the bar, it is only the landlord who is at risk when the tenant fails to obtain proper coverage or any coverage at all. Either way, the tenant is paying for the insurance and the notion that premiums for insuring a single building depends on who is “buying” the coverage, doesn’t seem very “right.” The value of the building is a constant, as is its use. Tenants can get lower premiums by buying lesser coverage, such as having an aggregate annual cap on all property losses under a blanket insurance policy. That’s not what a landlord wants to know.
What about liability insurance? Again, keep in mind, we’re talking “credit enhancement.” Therefore, much of the earlier discussion applies here as well. We’ll repeat, but just a little. The landlord and tenant each care that the other remain in business after being tagged with an enormous judgment liability. Frankly, the tenant cares less about the landlord’s well-being because someone else will become the landlord if the current one doesn’t survive. Granted, if that happens through a bankruptcy transaction, a bankrupt landlord could reject the lease but, absent unusual facts, tenants with leases anywhere near market aren’t going to experience that experience.
Large judgments against (financially) small tenants are a different story. Landlords have a legitimate interest behind requiring that such a tenant carry adequate liability insurance. Don’t ask us what constitutes “adequate,” but please don’t ask Exxon to carry $2 million dollars of commercial general liability insurance.
By this time, we’re figuring that many readers are screaming at us: “additional insured, additional insured, additional insured.” Well, here’s our take, one for which none of the flak we have ever gotten makes us change our mind. Landlords and tenants shouldn’t fight with each other just to “protect” their own insurance company’s fisc. For one, if you want to be sure you have insurance coverage, choose and control your own policy(ies). Being named as an additional insured on someone else’s policy is not a substitute for your own insurance. You need your own policy anyway and it will answer for any claims against you.
Before we give our take on what we expect to hear from naysayers, we’ve got to get this out (yet again). Tenants pay for their landlord’s insurance. That means that tenants are paying for two policies. So, what landlord isn’t going to carry its own insurance? Even in single tenant, absolute net lease deals, it is a foolish landlord that doesn’t carry its own liability insurance (on top of carrying the property insurance and charging that premium back). We’re not going to raise the issue of anti-indemnification laws or matters of public policy. Landlords can have liability having no connection to the property itself.
OK, but if claims are made against my policy, won’t my premiums go up? And, if they do, wouldn’t I (the landlord) be better off trying to get at least one tenant’s insurance company take the hit? We argue: “No, your premium won’t go up.” If your property is claim-plagued, your rating may change, but that has little to do with whose carrier stepped forward to handle any particular claim. While not directly comparable, think about your automobile insurance. Do you think carriers analyze “who was a fault in the accident” when assessing you as an insurance risk?
Further, whatever the range of insurance costs, the per square foot cost for liability insurance is pretty low, and the greatly feared “increase” makes no measurable difference in the cost of leasing from you or from the landlord across the street. To our understanding, the potential differences in insurance costs are immaterial in the economic decisions made by tenants. Lastly, most retailer pay a proportionate share of operating expenses from day one, and the landlord gets a recovery rate equal to its occupancy rate at the property. So, even if premiums did go up because of isolated claims (as contrasted with a lousy, claim-prone property), landlords don’t get much, if anything, by shifting some claims to their tenants’ carriers. All they do is help their own carrier’s bottom line.
Our last thought for today is: “if requiring the other party to carry certain insurance is so important, important enough to spend negotiating dollars on those “fights,” why don’t most landlords and tenants monitor the continued existence of such coverage each fought so hard for the other to carry?” Sure, a handful of landlords keep track of their tenants’ continuing coverages, but that is, by far, the exception. Do any tenants keep track of whether they are really named as additional insureds under their landlord’s policy? There must be some, but we’ve never met them.
Lenders are much better at making sure that their borrowers carry the require insurance, but they all (with a small number of exceptions) have insurance policies that automatically kick in if a borrower fails to have coverage. And, we’re not talking of “forced coverage.” We’re talking about ongoing, back-up policies.
We can overcome our fear of the dreaded “insurance” if we take time to study it. Ruminations has a “take” not always shared by our leasing and real estate colleagues. It is far, far more often shared by insurance professionals. The only way readers will know which side to take in these issues is by spending some time to learn about insurance – to attend good programs; to read good reference sources; to engage with genuine insurance professionals. We’re confident that those who do so will accept our “theories,” but know the limits of what Ruminations has to say; i.e., learn where Ruminations has gilded the lily.