Alex Wright

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at riskletters@lrp.com.

Property Risk

Revving Up Motor City

A Detroit renaissance is raising optimism, but properly insuring properties is a challenge.
By: | February 19, 2015 • 7 min read
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Soaring unemployment, a dwindling population and the collapse of its automotive industry — not to mention a largely dysfunctional property market — all contributed to Detroit’s infamous demise.

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The city hit rock bottom on July 18, 2013, when it filed for Chapter 9 bankruptcy with a staggering $18.5 billion debt — the largest municipal bankruptcy in U.S. history.

But in November 2014, having secured a major restructuring deal, Detroit emerged from bankruptcy, offering a new dawn of hope for the city’s residents.
The key to that brighter future is the city’s real estate market, which is undergoing a boom. Investors are snapping up vacant commercial and residential properties for redevelopment.

But variations between real estate market values and replacement costs are making some projects fiendishly difficult to insure.

VIDEO: The Telegraph visits the abandoned skyscrapers of Detroit, where the population has fallen from 2 million to 800,000, and some residents and entrepreneurs who are searching for solutions.

Redevelopment Renaissance

Investment is red hot in the 7.2-square-mile area that stretches from Downtown, Corktown and Midtown to the riverfront and Lafayette Park, with new restaurants and retail outlets opening every week.

Investors from far and wide, including Warren Buffett, are being lured by cheap property prices, and the revitalization of the city’s hub is driving demand for the newly converted apartments and business premises.

Such is the pace of growth that more than two dozen development projects have been completed or are in progress, according to the Downtown Detroit Partnership, a public-private partnership aimed at revitalizing the city.

These include the new $450 million Detroit Red Wings arena, and the renovation of the former Packard plant, which has stood derelict since the late 1990s.

“It’s been a contagion that’s spread, with investors keen to snap up a piece of real estate and tenants opening stores and restaurants all over the city.” — Daniel Stern, partner, Lormax Stern Development

Driving this redevelopment boom are entrepreneurs such as Detroiter Dan Gilbert, CEO of Quicken Loans, who has pumped more than $1.5 billion into 65 projects across the city over the last five years.

Allan Mallach, senior fellow at the Center for Community Progress, a Washington, D.C.-based advocate for land reuse and neighborhood revitalization, said that the bankruptcy and restructuring has given the city a fresh start.

“What it has done is to relieve some of the financial obligations that had to be met, which, in turn, has improved the net picture,” he said.

Daniel Stern, partner at Lormax Stern Development, a real estate developer, said another positive is that commercial prices climbed dramatically during the bankruptcy, particularly in the Downtown and Midtown areas.

“It’s been a contagion that’s spread, with investors keen to snap up a piece of real estate and tenants opening stores and restaurants all over the city,” he said. “In the last year alone we have had about 15 new restaurants open, which is more than we had in the last 10 years.”

Tale of Two Cities

But while Downtown is undergoing a renaissance, the contrast with the more deprived areas of the city couldn’t be starker.

Detroit’s housing market bubble burst in 2006, and the financial crisis two years later sped up the precipitous decline. It resulted in an acceleration of the number of abandoned homes in the city, with around 78,000 buildings and as many as 100,000 homes currently standing vacant, according to the latest estimates.

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According to the Wayne County Treasurer’s office records, more than 17,000 foreclosed properties were sold at auction last year, mainly in Detroit, with some properties going for as little as $500.

One of the main challenges for Detroit now is to extend the success enjoyed Downtown to the more struggling areas within the city’s 138-square-mile limits.

“Since the bubble burst in 2006,” Mallach said, “people’s mentality has been that the city is on the way downhill and that their property prices can only go one way so they might as well get out.

“To that extent, the bankruptcy process and the emergence from bankruptcy has started to change that mind-set and has given people a new hope.

“The fact is that the city is now getting more attention from prospective investors, but the question is whether they are the right kind of investors with long-term horizons or simply those who want to make a quick buck within three or four years.”

Risky Business

Buying a property in these areas is easy, but getting a mortgage is a whole different matter, particularly in the more deprived neighborhoods, according to Eric Larson, CEO of the Detroit Downtown Partnership.

“The biggest challenge is that it’s nearly impossible to get a mortgage and to leverage these types of properties because you just don’t have the market comparables to support any kind of structured debt,” he said.

Rick Miller, national property practice leader, Aon Risk Solutions

Rick Miller, national property practice leader, Aon Risk Solutions

Another problem is that some of Detroit’s older buildings are harder to insure because they are more susceptible to mechanical and electrical faults and pipes bursting, particularly in the winter, when temperatures can drop below 32 degrees, said Rick Miller, national property practice leader for Aon Risk Solutions.

“From an insurance perspective, if a property is in disrepair or neglected, you have to look at whether its mechanical and electrical systems are functioning properly and whether there has been any water damage,” he said.

“Then there is the ‘neighborhood effect’ where you might buy a property in an area where there is a problem with vandalism and crime that could potentially impact you when trying to get insurance.”

Michael Adkins, vice president and manager of Chubb Group of Insurance Cos. in Troy, Mich., said: “Structural deficiencies in a property may increase the severity of a loss and could lengthen the time it takes to get the property back to its intended business purpose.”

Valuing the property can also be problematic, given the huge discrepancy between market value and replacement value costs in some areas, said Adkins.

“I see a lot of buyers’ reports where the purchase price is in no way reflective of the replacement costs.”— Martha Bane, managing director, property practice, Arthur J. Gallagher & Co.

“Commercial real estate owners often look to insure property based on what they paid for the building or the market value,” he said. “But the property’s value could be more or less than the actual cost to replace the structure based on construction costs at the time of the loss.”

Martha Bane, managing director, property practice, Arthur J. Gallagher & Co.

Martha Bane, managing director, property practice, Arthur J. Gallagher & Co.

Martha Bane, managing director of Arthur J. Gallagher & Co.’s property practice, added: “I see a lot of buyers’ reports where the purchase price is in no way reflective of the replacement costs.”

Brian Ruane, who leads Willis’ real estate practice, said that occupancy was another issue.

“One of the main factors that underwriters look at when assessing a property is occupancy,” he said.

“Low vacancy rates can increase the risk of vandalism and, in the case of rental properties, the owner’s ability to keep up with their tax and mortgage repayments if they have no tenants.”

Property Woes

But, above all, the No. 1 challenge remains kick-starting the city’s mainly under-performing housing market.

One insider told Risk & Insurance® that the city’s bankruptcy merely compounded the fact that Detroit remains one of the weakest property markets in the country.

“Detroit has the lowest commercial office rents, the highest vacancy rates and the lowest prices for single family housing anywhere in the U.S.,” he said.

“The risks involved in getting into the market are considerable, but one of the main advantages with Detroit is that you can come in and make an instant impact. Within a year you can be running your own business or managing three or four rental properties.”

Stefan Hilts, a director in Fitch’s U.S. RMBS group, said the city’s house prices are still 36 percent lower, in real terms, than their peak in April 2006, just before the bubble burst, mainly as a result of a falling population, rising unemployment and a weak economy.

“Prices are still massively undervalued given that there’s still a population and there’re still people working in the city,” he said.

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However, a number of institutional and individual investors from Wall Street to China willing to take the plunge have been lured by the low prices, which have started to climb again in the more desirable areas.

Dr. Svenja Gudell, senior economist at property firm Zillow, warned however that there could be tough times ahead if the less well off areas continued to struggle.

“Roughly 30 percent of Detroit’s housing units already lie vacant, and without job growth and a healthy economy to attract new workers, what demand there is will inevitably dry up.

“Those homes currently vacant will remain so, blighting the cityscape and creating the double whammy of downward price pressure in the city’s neighborhoods.”

But while hope remains, the prospects for Detroit’s property market, at least in the short-term, are looking up.

Larson said: “I think that Detroit is going to be in significantly better shape post-bankruptcy, but we need to make sure that we don’t become just a tale of two cities.”

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at riskletters@lrp.com.
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Reputation Risks

Risks of Celebrity Sponsors

Companies should review 'what if' scenarios before attaching their products or services to a celebrity sponsor.
By: | February 11, 2015 • 3 min read
Topics: Reputation
Sponsorship risks

Companies are using actors, prominent sports figures and other celebrities to endorse their products more than ever before.

However, while they may generate lots of publicity around a product or service, not all of it is good publicity.

You only have to open up a copy of the newspaper to read about  scandals engulfing stars such as Bill Cosby, Brian Williams or Tom Brady with the New England Patriots’ ‘deflate-gate’ saga.

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Sponsors have reacted by withdrawing their support, most notably in the NFL, where domestic violence allegations hanging over the sport prompted Procter and Gamble to pull the plug on a deal to supply players with pink mouthguards during Breast Cancer Awareness Month and cancel all on-field marketing.

The risks for any sponsor associated with this type of negative publicity are infinite, said experts, often resulting in the cancellation of lucrative advertising and marketing contracts, ultimately costing the company millions of dollars in lost revenue.

Worse still, the sponsor may be forced to pull its product from the market altogether, with the end result that millions of dollars are wiped off its share value.

The main risk of hiring a celebrity to endorse a product is the unexpected or disgraceful behavior of that individual, or unforeseen events such as death. — Lori Shaw, executive director, entertainment practice, Aon Risk Solutions

Lori Shaw, executive director of Aon Risk Solutions’ entertainment practice, said the main risk of hiring a celebrity to endorse a product is the unexpected or disgraceful behavior of that individual, or unforeseen events such as death.

“The first step is to analyze the potential risks, discuss ‘what if’ scenarios; outline the financial consequences; and to be aware of the risks that can be avoided, those that can be transferred contractually to the celebrity or talent, those that can be transferred to insurance and the risks that must be retained,” she said.

Shaw said that companies need to take a holistic approach to their branding and marketing activities in order to assess the potential impact of any adverse publicity on their balance sheet.

Nir Kossovsky, CEO, Steel City Re

Nir Kossovsky, CEO, Steel City Re

Nir Kossovsky, CEO of Steel City Re, a corporate reputation measurement and risk management specialist, said another major problem of negative publicity is the damage to a company’s reputation.

“The primary risk is that an adverse behavior at an event or by a celebrity will be viewed by stakeholders as a reflection of that company’s culture, values or operational ineptitude,” he said.

“In this situation where the stakeholder holds the company culpable for any such action, often they will respond by altering their future expectations and exercising their financial clout, usually to the company’s detriment.”

Kossovsky said that, rather than calculate the potential risk, sponsors need to first determine the value gained from the sponsorship deal, and the costs of acquiring that value.

Then they must assess the costs of communicating to stakeholders the steps it took to mitigate against any adverse events and publicity that may occur, he said.

“There are two instances when a company should walk away from a deal,” he said.

“The first is if the costs of a parallel communication strategy coupled with the direct costs of sponsorship outweigh the value of the expected gain.

“The second is if, on objective reflection, there is a compelling case that the average stakeholder will hold management culpable for an adverse event no matter what the management says to the contrary.”

To mitigate against these risks, corporations are increasingly turning to specialized insurance plans and writing clauses into their contracts allowing them to cancel a deal if the celebrity is considered to have acted in an inappropriate manner that may damage the company’s brand.

Recently, AIG launched a new policy protecting sponsors that hire celebrities to endorse their product.

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Celebrity Product RecallResponse is triggered by any “actual or alleged criminal act or distasteful conduct” from the celebrity that has a significantly adverse impact on a company’s product.

It covers certain costs incurred by companies to remove or recall those products bearing the celebrity’s name and image, as well as the costs of removing advertising.

“In this age of social media and instant news,” said Jeremy Johnson, president and CEO of Lexington Insurance Co., which provides the policy, “reports of indiscretions by celebrities or high profile athletes can spread worldwide instantly, with swift, adverse implications for products or brands associated with the individual.”

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at riskletters@lrp.com.
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Supply Chain Risks

Breaking the Chain

Reliance on supply chains has hiked the number of business interruption claims, which cost nearly one-third more than property claims.
By: | February 4, 2015 • 5 min read
Allianz Risk Barometer

The increasing interconnectivity between businesses and their customers and suppliers has resulted in a large rise in business interruption (BI) and supply chain claims, according to industry experts.

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Combined with a greater frequency and severity of natural disasters and extreme weather globally, as well as growing geo-political instability and unrest, this has left companies more exposed than ever before.

The Allianz Risk Barometer 2015 survey released in January revealed that BI and supply chain risk is the No. 1 peril for the third year running, with 46 percent of respondents rating it one of the three highest risks for firms.

“But because no single party owns the whole supply chain process it makes it hard to establish where the risk lies and how to measure it, particularly in areas such as cyber where there are multiple layers of ownership.” — Gary Lynch, founder and CEO, The Risk Project

The study found that the average BI claim at $1.36 million is 32 percent higher than the average property damage claim at $1.03 million, with the subsequent disruption amounting to more than the initial physical damage.

Gary Lynch, founder and CEO, The Risk Project

Gary Lynch, founder and CEO, The Risk Project

Gary Lynch, founder and CEO of The Risk Project, a supply chain risk management specialist, said that complex supply chains shared by multiple parties with different business models “inherently” had a large degree of risk attached to them.

“One of the biggest challenges from a risk manager’s perspective is that not only do they have to understand a company’s operating model, but also the broader economic model and the models of their business partners,” he said.

“But because no single party owns the whole supply chain process it makes it hard to establish where the risk lies and how to measure it, particularly in areas such as cyber where there are multiple layers of ownership.

“There’s no doubt that this increased interconnectivity is resulting in greater claims.”

Outsourcing Increases Complexity

Brian Kirwan, head of market management at Allianz Global Corporate & Specialty (AGCS) Regional Unit London, said that supply chain risk had been exacerbated by the global trend toward outsourcing over the last few years, adding to its complexity.

“What we are seeing is that continued globalization is creating complexity in the supply chain, which is the biggest challenge for risk managers.” — Brian Kirwan, head of market management, Allianz Global Corporate & Specialty Regional Unit London

“What we are seeing is that continued globalization is creating complexity in the supply chain, which is the biggest challenge for risk managers,” he said.

In addition, he said that BI losses as a proportion of an overall claim were also on the increase, which, in turn, was having a significant impact on company revenue.

“The first key component to get to grips with this is understanding the critical pieces of the supply chain, including the suppliers, and what impacts them — not only the credit risks, but also the catastrophe and insurance risks, as well as the concentration of risks,” he said.

Paul Carter, global head of risk consulting at AGCS SE, added: “Businesses spend a lot of time assessing direct damage and looking at their own BI impact but more work needs to be done analyzing the risks associated with suppliers and customers.”

Perry Rotella, group executive, Verisk supply chain risk analytics business

Perry Rotella, group executive, Verisk supply chain risk analytics business

Perry Rotella, group executive of Verisk’s supply chain risk analytics business, said that the main problem is while companies may have visibility of their direct suppliers, often they don’t have the necessary oversight of how the supply chain fits together and the geographical areas their production sites are located, as with the Thai floods in 2011.

“This increase in complexity combined with a growing number of natural disasters, extreme weather and geo-political instability has increased the risk for companies,” he said.

He added that, further down the line, the slightest supply chain disruption can have a knock-on effect, causing a company’s share price to drop, on average, by 7 percent, and often taking months to recover its value.

Chris Fischer Hirs, CEO of AGCS SE, added: “The growing interdependency of many industries and processes means businesses are now exposed to an increasing number of disruptive scenarios.”

The company’s survey of more than 500 risk managers across 47 countries found that the causes of BI that companies feared most were fire/explosion (43 percent) and natural catastrophes (41 percent).

Second only to BI and supply chain risks were natural catastrophes (30 percent) and fire/explosion (27 percent), according to the report.

Cyber (17 percent) and political risks (11 percent) were the biggest movers. Cyber crime/IT failures moved into the top five business risk ranking for the first time and are now among the top three risks in the U.S.

Meanwhile, loss of reputation (61 percent) and BI (49 percent) were cited as the main causes of economic loss following an incident.

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But despite the increased awareness of cyber risks, many companies still underestimated the different impacts of it on their business, according to 73 percent of respondents.

Political/social upheaval was also a much bigger concern for businesses, climbing nine places to ninth. It’s also the second biggest cause of supply chain disruption (53 percent) after natural catastrophes, said the report.

By sector, the survey found that natural catastrophes remain the main risk for the engineering and construction industry, while BI is the biggest threat for manufacturers, and legislative and regulatory changes are top of the agenda in financial services.

Long-term, climate change and natural catastrophes, as well as so-called “disruptive technologies” such as 3D-printing and nanotechnology remain the biggest threats to companies, the report concluded.

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at riskletters@lrp.com.
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