Davis Smith, Bradley
3 August 2020Actuarial & underwriting

Generating captive revenue through tenant liability programmes

The real estate sector is facing numerous economic challenges. The property and casualty markets are hardening, while tenants are looking for rent concessions. Meanwhile, moves by some businesses to allow more working from home could significantly reduce demand for office space.

When insurance expenses are increasing, a captive may be used to stabilise premium costs by increasing deductibles and insuring the deductibles in the captive. The higher deductible should lower the premium cost to third party carriers while allowing the insured to place the retained risk in its captive and benefit economically from positive claims experience.

“For property owners with multiple properties, this structure provides the benefit of an additional source of revenue.”

In addition to traditional cost-saving benefits, captives can generate an additional revenue stream for landlords through tenant liability programmes.

Property owners are subject to certain risks associated with their tenants, such as risk of fire triggered by tenant-owned kitchen appliances. To mitigate these risks, leases may include obligations for the tenants to provide insurance coverage for the benefit of the landlords. Such lease terms require tenants either to provide proof of coverage or to pay a fee for the landlords to procure the necessary coverage, which is provided by the landlords’ captives.

For property owners with multiple properties, this structure provides the benefit of an additional source of revenue as well as diversifying the risk of a catastrophic casualty loss from any one apartment unit.

Coverage options

A few different products may satisfy a tenant’s obligations under a lease. The most basic coverage option is tenant liability insurance, which generally protects the landlord against liabilities created by the tenant, including damages to property from fire caused by the tenant and/or liabilities from third party suits for incidents occurring within the premises.

The only benefit the tenant receives under this type of policy is the satisfaction of its obligation under the lease. It does not protect the tenant’s property against loss.

The captive may provide more comprehensive coverage that includes protection for the tenant’s property. This coverage, sometime called renters insurance, protects not only the property of the landlord but also the tenant. The increase in coverage, and corresponding risk, results in higher premiums placed in the captive.

Tenant liability programmes are typically structured through master group policies. A single master policy issued to the primary landlord entity covers all of the affiliated entities to the extent premiums are paid. The affiliates pay for coverage on a unit-by-unit basis for each tenant electing to pay the fee rather than procure its own coverage.

If the coverage offering is expanded to include renters insurance, then it is important to analyse the state law treatment of group insurance. Some states restrict or prohibit group insurance offerings unless the insureds have some form of shared interest. Thus if the property is located in a particular state that prohibits group insurance unless the insureds have a common insurable interest, the landlord may have to look at other options to offer the coverage (for example, through a risk retention group) or simply prohibit the offering of renters insurance in that state.

Despite the state law hurdles that may exist for offering renters insurance through a captive, interest in tenant liability captive programmes is definitely on the rise. When combined with other captive benefits (stabilisation of premium costs, increased coverage offerings, etc), property owners can confront the difficult economic environment with captive insurance structures that enhance their bottom lines.

Davis Smith is a partner at the law firm Bradley. He can be contacted at: dhsmith@bradley.com