The use of insurance in industrial real estate is designed to hedge against a variety of risks related to the ownership, occupancy, and operation of industrial property. Insurers fundamentally protect the insured from financial loss both during and after the period of ownership or tenancy.
Insurance in industrial real estate has evolved from policies to protect factories from fire damage to modern policies dealing with emerging risks facing the industrial property owner and occupant.
In many ways insurance is an unsung hero in industrial real estate. It allows interested parties to insure themselves and other parties. Without it, the financial risks associated with the ownership of and operation within industrial real estate would be discouraging, if not disqualifying, to prospective industrial property owners and occupiers.
Liability and property insurance are the two common insurance policy types associated with industrial real estate today. Under liability and property insurance policy types are several common subtype policies which cover specific liabilities and types of property damage.
In addition, there are many insurance policy subtypes under liability and property insurance which can insure around risks unique to the specific property or operation. There are also insurance policies designed to insure around new risks based on current events, such as pandemic insurance in the wake of COVID-19 or terrorism insurance after 9-11.
Liability insurance, sometimes called third-party insurance, is insurance designed to defend the insured against third-party claims. While other types of insurance will pay-out to the insured based on the claims of the insured, liability insurers offer protection against a third-party claim and the cost to defend against said claim. (See below for liability insurance requirements under a lease)
Commercial General Liability (CGL)
As the name implies, commercial general liability insurance covers the insured for liability from bodily injury, personal injury, and property damaged caused by the insured’s business, products, or on their premises. Whether an industrial property is owner-occupied or leased, commercial general liability insurance is standard coverage for industrial businesses.
Worker’s compensation insurance is a form of liability insurance which protects the wages and medical benefits of employees injured in the course of their employment. Known as a “compensation bargain”, worker’s compensation was created as a trade-off giving worker’s coverage for workplace accidents in exchange for relinquishing their rights to litigate due to their injuries.
Although not required in a few U.S. states, most industrial landlords will require tenants hold worker’s compensation coverage in the lease to mitigate their exposure to workplace accident litigation and to protect their tenant’s ability to pay rent (which would presumably be reduced if a substantial award was given to an injured worker).
Business Auto Liability
Automotive insurance is required of anyone who owns a vehicle in the U.S. but also is commonly required of a tenant in commercial lease agreements. Some lease agreements will require the tenant to add the landlord as an additional insured and obtain minimum coverage limits under their automotive and vehicle insurance policies. Both stipulations are designed to protect the landlord from liability due to vehicle-related accidents on the property.
Environmental insurance protects the insured against the financial risks of environmental related liabilities. These policies can be obtained in the normal course of business as a protective measure against environmental risk to the tenant or landlord, and also can be purchased in specific situations to protect against unknown risks following remediation of a recognized environmental condition.
Any insurance that insures against damage to property can be called property insurance, but in industrial real estate there are typically two separate types of policies. The first covers the real estate. The second covers the personal property of the occupant.
Property Insurance for Real Estate
Commercial property insurance is designed to insure the real estate against catastrophic loss. However, the amount the insurance will cover depends on whether the insurer values the improvements based on replacement value or actual cash value.
If the insurer values real property improvements on replacement value, they will typically pay the amount of cash needed to replace the insured property. Alternatively, if the insurer values real property improvements on an actual cash value, they will subtract depreciation from the replacement cost. Given the potentially significant difference in payouts, policy holders should always confirm which method their insurance provider is using.
Under most policies, property insurance covers every cause of loss except those causes that are specifically excluded. This type of policy is called special perils. Special perils policies for commercial real estate will generally exclude losses due to earthquake, flooding, governmental actions, nuclear attacks, insects, and mold.
For items excluded from a special perils policy, there are usually two options for the policyholder to gain coverage. First, they can add coverage to an existing property insurance policy as an endorsement, or a modification to an existing policy. Second, they can obtain a wholly separate policy to cover the specific risk.
Often policyholders purchase endorsements or separate policies for risks associated with a certain location. One example is earthquake coverage. Another is flood insurance. For both the costs related to the premium and deductible are largely dependent on the location of the property.
Earthquake Policy or Endorsement
In the case of earthquake, premiums are based on a varying amount per $1,000 of property valuation. The varying amount usually ranges from $1 in situations considered low risk up to $15 in high risk situations with deductibles ranging from 10% to 15% of the property valuation.
Unsurprisingly, California and the rest of the Western U.S. is on the higher end of earthquake premiums at roughly 10 times the rest of the U.S.. In these areas the cost of earthquake insurance is not nominal and can be a significant increase in operating costs for the property owner or the tenant if the cost of the policy is passed through.
Flood Policy or Endorsement
Like earthquake insurance, flood insurance cost is largely based on location. Premiums and deductibles for flood insurance policies are determined by the Federal Emergency Management Agency (FEMA) flood zones which range from coastal areas with high risk of flooding to areas with little to no risk of flooding.
Properties with government backed mortgages in areas that are considered to be at a high risk of flooding are required to have flood insurance. Since flood insurance is required in certain instances, the government via FEMA and the National Flood Insurance Program is the largest backer of flood insurance policies in the U.S. and such insurance is seen as an alternative to disaster relief.
Unlike earthquake and flood insurance, commercial property and liability insurance providers must offer terrorism insurance to policy holders according the Terrorism Risk Insurance Act (TRIA). Originally signed in 2002 following the September 11th, TRIA is a Federally supported program which originally started as a short term reinsurance program to help impacted insurers recover from terrorism events, the predecessor to TRIA has been extended through 2027.
Property Insurance for Personal Property
Since property insurance for real estate only insures improvements as defined within the policy, there is a need for insurance of affected property in addition to those covered. Typically such additional insurance is obtained to protect the value of any “personal” property on the real estate, which may include inventory, machinery, equipment, furniture, and other such items. Such policies are often mandated under lease agreements to limit potential litigation and ensure the viability of a tenant should a catastrophic event occur.
Rental Value Insurance
Another common property insurance policy found in industrial lease agreements is rental value insurance. As with personal property, property insurance on real estate may not cover the loss of rental income due to physical loss or damage to the property. Rental value insurance protects the landlord or building owner against such loss of rental income. Many industrial leases allow landlords to pass-through the premiums of rental value insurance policies to tenants as an operating expense.
Insurance Requirements in a Lease
When an owner of an industrial property also owns the business operating in the property, they typically can choose the insurance coverage they need depending on their requirements. Conversely, when an industrial company leases an industrial property, the landlord will often ask for specific insurance requirements, many of which have been discussed in this post previously.
Liability Insurance in a Lease
Generally, commercial general liability insurance is the most common policy type required in any industrial lease. Even though a tenant has leasehold ownership of a premises under a lease, the landlord also has liability risk for any accident that might take place on the premises. The liability risk to both the tenant and landlord is unique and explains why leases generally focus on liability insurance requirements to a greater extent than other policy types.
Requirements for commercial general liability insurance policies in a lease typically include the following stipulations:
- Policy Type
- Primary insurance policies are the insurance policies which pay claims first
- Umbrella insurance policies are the insurance policies which typically pay after the primary insurance policy has reached its coverage limit. They provide extra coverage against liability and the cost of defending against liability lawsuits
- Coverage Limits
- Occurrence: The amount of liability insurance coverage per occurrence of liability. This typically is a minimum of $1,000,000 in industrial leases and are often higher.
- Aggregate: The amount of liability insurance coverage over a period of time, usually over one year. This typically is a minimum of $2,000,000 in industrial leases and again are often higher.
- Limits and Primary and Umbrella Policies: Leases will often state that liability coverage limits may be met with a combination of primary and umbrella policy limits.
- Defined Liability Burden
- The extent of property, under the lease, in which each party is liable. Typically this is defined as the Premises under the lease but it should be clearly understood by the parties where liability ends and begins.
- The lease should also cover liability coverage for contractors and other related parties which the tenant or landlord may encounter in the course of doing business.
- Financial Strength and Size Rating
- Leases will sometimes require liability insurance providers have a certain financial strength rating and/or certain financial size from a stated agency, such as AM Best, S&P, Moody’s or Fitch
- Who Obtains and Who Pays
- Always depends on what the lease says!
- Landlord will most often obtain (if they elect to or are required to):
- Property insurance on the real estate
- Rental value insurance
- Environmental insurance
- Additional liability policy
- Tenant will most often obtain (if they elect to or are required to):
- Property insurance on personal property
- Worker’s compensation
- Business auto liability
- Landlord will sometimes pay for property insurance on the real estate, environmental insurance, and additional liability insurance.
- Tenant will typically pay for most if not all of the cost of insurance, either directly or as a pass-through operating expense. Such costs are negotiable and should not be automatically borne by the tenant unless consistent with the market and reasonable for the situation.
- Covering the Landlord on a Tenant Policy
- Additional Insured: Tenant’s insurance provider will add the landlord entity as an additional insured party via a specific or blanket endorsement. Once added the landlord will also be covered under the tenant’s policy typically only for the property in question under the lease. There is usually minimal cost to add additional insured entities to a policy. Adding the landlord as an additional insured is a standard requirement under most leases.
- Named Insured: Tenant’s insurance provider will add the landlord as an insured entity or person in the policy declarations. This is different than additional insured, which typically only covers the property in question and may not offer as broad of coverage to employees and other related entities of the named insured. Adding the landlord as a named insured is not typically required under most leases.
- Interested Party: Tenant’s insurance provider will add the landlord as an interested party which identifies the landlord as having an interest in the policy. Depending on the policy, the landlord may or may not be covered by the policy if listed as an interested party. At a minimum, interested parties would receive notification of any changes to the policy such as cancellation or modification. For example, if the tenant obtains property insurance on the real estate under the lease the landlord would typically require they be listed as an interested party under such policy to insure against any lapse in coverage.
- Cross Liability: Cross liability is when one or more parties who are insured under the same policy sue each other, the insurer should protect both parties. Since cross liability is not always part of a liability insurance policy, leases will typically mandate that only a liability insurance policy with a cross liability endorsement is acceptable.
- Notice of Cancellation: Similar to the idea of the landlord being listed as an interested party in the liability insurance policy, leases will typically mandate that the tenant provide notice of cancellation, modification, or expiration of any policy under the lease. Furthermore, leases will sometimes require that a policy is only cancellable or able to be modified with 30 days notice from the insurer, otherwise the tenant would be in default.
- Waiving Rights of Subrogation: Subrogation allow an insurer to see restitution from a third-party deemed responsible for their incurred claim costs. In other words, it allows an insurer to “fill the shoes” of the insured who filed the claim in order to sue for damages. Leases will commonly have the tenant, landlord, or mutual waivers of subrogation explicitly waiving the rights of the insurers or any party to subrogate. Such waivers can be unilateral, most commonly when the tenant waives their rights under a liability policy, or mutual, when both the tenant and landlord waive their insurers right to subrogate. The reason is simply to avoid costly litigation amongst the parties and to limit payouts to just the insurance claim alone.
Evidence of insurance is typically transmitted to the parties in a lease via an insurance binder. An insurance binder will typically show the insurer information, policy duration, insured information, coverages, limits, and endorsements.
Sometimes leases will contain exhibits which show the insurance requirements and ISO or Acord forms required under the lease. This is not a standard practice since most leases will cite and rely on the policy documents and binders in question for specific details.