Aon Risk SolutionsReal Estate

Risk. Reinsurance. Human Resources.

IntroductionWelcome to this winter edition of Property Eye, Aon’s review of the key risk topics facing commercial real estate investment funds.

In this edition, we lead with a market review from the underwriting ‘box’ as broker David J Tilley draws on his contacts to discover what issues most concern CRE insurers approaching 2017.

A majority of Aon’s CRE customers have assets across the continent. Mark Manwaring and Bisma Mahmood explain in their article ‘Bloc in the Road’ how claims for restitution in former communist states of Eastern Europe are fuelling growth for title insurance.

We pride ourselves on supporting CRE funds at every step in the investment process, with deal-making an essential point in the cycle. Nuala Read, Director at Aon Strategic Advisors & Transaction Solutions explains how Warranty and Indemnity insurance has emerged into the mainstream.

On the operational risk side, Property Eye features a guest comment from Axa Insurance’s Head of Customer Risk Management, Douglas Barnett, advising how landlords can protect large, out of town warehouses.

Cyber risk is becoming all pervasive and in a revealing article, Adam Peckman, Global Practice Leader for Cyber Risk Consulting at Aon, shows why ‘Smart Buildings need Smart risk management’.

Finally, we consider the increasing influence of technology on claims. Dylan Allen, Claims Director at Aon Real Estate, explains why claims data should no longer be the preserve only of underwriters.

We do hope you find this edition of Property Eye useful and we welcome any feedback that you wish to provide. Please contact real.estate@aon.co.uk.

Property Eye Winter 2016

Contents1 Introduction2 Looking ahead to 2017: What

does the insurance market think?

3 Bloc in the Road: How CRE funds are managing restitution claims

4 Warranties and Indemnity Insurance: A mature market?

6 Take steps to protect large out of town vacant warehouses

8 Smart buildings need smarter risk management

10 Claims Management: From raw data to risk understanding

Property Eye | Aon Risk Solutions | December 2016 2

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Looking ahead to 2017: What does the insurance market think?

It goes without saying that Brexit will dominate the headlines, for better or worse, for the foreseeable future. Few could have anticipated such an uncertain business climate and any poll you would care to mention will undoubtedly place it at the top of the risk register. David J Tilley | Broking Manager,

Aon Real Estate Practice

The same can also be said from our own conversations with insurers. Having spoken with a number of leading underwriters before writing this introduction without exception, Brexit cast a big shadow over their answers.

Nevertheless, the insurance market has other immediate challenges to contend with; many of which have a direct influence on you, the buyer, as well.

Commercial real estate funds in the UK and Europe who transact with insurers in the London market are experiencing historically competitive conditions. This of course means more customer choice and careful decisions to be made at renewal. There will be reminders from established real estate insurers that new entrants into the market are looking to increase market share, and that their offerings may be caveated by short term, unsustainable premiums.

For those of you familiar with Aon and its partners, the focus on risk management has become a prevailing theme and this will continue in 2017. Underwriters will encourage clients to review, in order to enhance, their portfolio management. Meanwhile, property portfolios will always be measured in terms of their claims performance and hopefully this collaboration will lead to more competitive solutions for all.

In 2017, your relationship with the insurance sector as a whole will also begin to change as the Insurance Act settles into its first year.

Replacing centuries old law in the UK, the Act drastically alters client duties in relation to matters such as innocent non-disclosure. Aon and its peers alike have a number of new responsibilities as well, most importantly supporting you in the Act’s primary duty of making a fair presentation of your risk.

Finally, the continuing impact of flood, extreme weather and natural catastrophe will remain at the top of the sector’s risk register. The recent earthquakes in Italy were a harsh reminder of the power these events can have over lives and property and responding to insured losses from extreme weather events remain a priority for real estate insurers. Expect those responsible for your insurance programme to seek close collaboration to ensure asset damage and business interruption are kept to a minimum.

For more information, please contactreal.estate@aon.co.uk

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Bloc in the Road: How CRE funds are managing restitution claims

A high proportion of Aon Real Estate clients have assets across Europe and demand for title insurance is rising as investors face obstacles requiring careful due diligence. Mark Manwaring and Bisma Mahmood explain how claims for restitution in the former Eastern Bloc and a continuing fire sale of non-performing loans after the financial crisis are fuelling growth.

1 Source; Radio Poland

2 Source: http://www.europarl.europa.eu/RegData/etudes/BRIE/2016/574400/IPOL_BRI(2016)574400_EN.pdf

Bisma Mahmood | Legal Indemnity Client Manager, Aon UK

Mark Manwaring | Legal Indemnity Director, Aon UK

There are moments when the real estate investment cycle can feel more akin to the pages of an historic novel than a series of business transactions.

Investors and developers with assets in the former Eastern Bloc will feel this more than most, as restitution claims in respect of property owned before World War II and the rise of communism are raising new challenges.

The Holocaust and post-war annexation of Eastern Europe into the communist bloc saw vast swathes of property expropriated. Decades later, as the Iron Curtain fell and the region emerged free into the 1990s, claims on property and assets once owned by families, church groups or historic corporations began to flood in from across the globe.

Many countries passed property restitution laws immediately after the fall of communism including the Czechs in 1990, Hungary in 1991 and Poland during the mid-1990s. Initially focused on the repatriation of communal and religious land or assets, each country’s legislation has developed in unique ways. Now, more than 25 years later there are signs that some countries are attempting to draw a line under certain issues, ostensibly to protect modern public buildings.

For example, in August 2016, Poland’s President Andrzej Duda signed into law new rules that will limit the return of property seized in Warsaw during the communist era to its original owners. Under the new law, Warsaw authorities will be able to refuse the return of land if it is now being used for a public purpose. Claims to buildings which were more than 66% destroyed after World War II can also be refused1.

With such a complex legal environment to contend with, restitution issues can be a significant hurdle in the 10 former eastern bloc member states of the European Union as well as neighbouring states in regions like the Balkans. Establishing title and understanding any potential issues has to be a key element of any transactional due diligence process.

To mitigate this risk, real estate investors are increasingly looking to title indemnity programmes.

A trend also driving demand is the continued volume of transactions in the non-performing loans sector.

In March 2016, the European Parliament’s briefing on non-performing loans in the Banking Union2 showed precisely where the continent stood in terms of loan ratios. Ireland (20.6%), Portugal (18.5%), Italy (16.9%), Greece (43.5%) and Cyprus (50%) all demonstrate the challenging situation for state banks who bailed out their domestic markets after the financial crisis.

For investors looking at distressed assets, availability has probably never been higher and governments are doing their best to make the environment more conducive to completing transactions quickly. In Italy for example, the government is trying to support investors with a new guarantee scheme for the securitisation of NPL purchases.

Investors in distressed assets like European NPL portfolios are mindful of their need to conduct careful due diligence so as not to fall foul of any unwelcome obligations they may also acquire. For instance, Spanish NPLs have frequently been found to contain clawback risks from bankruptcy proceedings in respect of previous owners. Investors are having to take care to understand their exposures.

Both restitution claims and NPL transactions represent the tip of a complex, multi-jurisdictional iceberg. The need to build a contingency for unexpected due diligence work has demonstrated the genuine value of title insurance and with a mature market prepared to underwrite risk in most countries, investors have a healthy choice of options.

For more information, please contact real.estate@aon.co.uk

Property Eye | Aon Risk Solutions | December 2016 4

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Warranties and Indemnities Insurance: A mature market?

For ‘niche’ lines of business, the challenge of weighing price over coverage isn’t always an option. Fewer available markets will often mean a ‘take it or leave it’ scenario as providers bask in their sphere of expertise. However, Nuala Read, Director at Aon Strategic Advisors & Transaction Solutions explains how Warranty and Indemnity has emerged into the mainstream with healthy competition generating a new set of decisions for real estate investors.

Nuala Read | Director, AonStrategic Advisors & Transaction Solutions

It has become apparent that there are some clear strategic advantages to using Warranty & Indemnity (W&I) insurance in corporate real estate transactions. These policies are increasingly being used to replace the seller’s post-closing financial cap in share agreements, allowing the (fund or PE) seller to achieve a clean exit at a “best price” for the asset.

For a long time, the M&A community had little choice of W&I insurers and for many deals the insurance was not attractive. But since 2010, we have seen it grow from use on occasional deals, to an increasing number of transactions across the world. Sector agnostic data backs this up, with one report indicating that in 2015 it was used in 14% of smaller M&A transactions (€25m to €100m), increasing to 22% for deals over €100m3.

W&I underwriters see real estate as much lower risk than other sectors such as manufacturing. For real estate deals in Europe, we have seen increased competition on W&I policy pricing and excess levels and the broadest cover offered to date.

However, now it is becoming ‘standard’ for the majority of real estate deals, there are new issues for clients to consider. Getting the best financial terms are a key part of arranging this insurance and this is usually done at the start of the process. W&I is put in place in two steps, with the first stage similar to “heads of terms” and the second stage, final offer is confirmed after the insurer conducts an assessment of the deal risks. Initial W&I terms are obtained from a range of insurers and are relatively light on detail; understandably, when making their decision most clients focus on the premium and policy excess.

As one of the leading advisors in this area, Aon’s M&A team has identified key differentials that are not immediately obvious in these initial insurer offers. When selecting the W&I insurer for the second stage, we discuss the client’s requirements for the insurance, what each coverage offer will look like (after insurer review) and claims servicing for W&I claims. All of which require careful guidance at point of sale, to ensure the W&I product is fit for purpose through the value chain.

Policy Cover W&I Insurers are becoming increasingly experienced at balancing the premium and coverage offered. Some offer broad coverage terms in the initial offer which remain consistent after the underwriting process, while others provide a much more limited product after their review; the latter frequently succeeding in the objective of appearing the most financially competitive. We caution that clients should be aware that the final coverage offer is likely to be much more limited when the insurer has puts up the lowest premium and excess to get the instruction.

The ‘Warranty Spreadsheet’For sellers offering this product to facilitate the deal, cover may not be of concern. However, a key point for the buyer’s acceptance of the policy is the cover offered. When the final cover offer is received, we recommend the buyer and their advisors conduct a thorough review of the ‘warranty spreadsheet’ (attached to the policy and sets out the cover position on a line by line basis). It is here that restrictions on the final coverage offer will emerge (such as the insistence on “seller’s knowledge” to certain warranties) and the true value of the policy will become clear.

3 Source: CMS European M&A Study 2016

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Claims The other piece of the puzzle for W&I is claims. Whilst historic claims activity has been very low (in line with claims on uninsured deals), the increased market penetration has generated an uplift and key W&I insurers confirm privately that claims ratios for W&I are increasing rapidly.

While there are very few claims in private M&A transactions, with the W&I, clients are always interested in details on whether these policies pay out. A recent report from one of the largest W&I insurers has provided some much needed information on their 15 years of claims history for this type of insurance. In particular, they confirmed the percentage of policies which received claims (13% for buyer policies) and outlined the areas which had had the most claims; 28% for financial statements, 13% for tax and 11% for contract breaches4.

Claims are of course a key differentiator. Some insurers have invested in experienced in-house capability while others are learning how best to service this market. Again, this issue is of more importance to some clients than others and is usually one of the factors considered in the final decision matrix.

Why shop around?At the moment, the majority of W&I policies are being bought on a deal by deal basis and the choice of insurer is determined by the offer for that particular deal. This is anomalous for typical corporate insurance programmes and could potentially leave clients at a disadvantage. In particular, with many real estate clients buying multiple W&I policies each year, there are opportunities to work with trusted insurance advisors helping to carefully select a panel of insurers. This approach can provide coverage and pricing advantages at the front end, but also can help in negotiations in the event there is a claim.

For more information, please contactreal.estate@aon.co.uk

4 Source: AIG W&I Insurance Global Claims Study (UK Edition)

Property Eye | Aon Risk Solutions | December 2016 6

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Take steps to protect large out of town vacant warehouses

A recent rise in reports of travellers forcing entry and setting up camp inside empty logistics warehouses has highlighted urgent security issues for landlords.

Douglas Barnett | Head of Customer Risk Management, AXA Insurance

As buildings with warehousing space of 20,000m2 – 40,000m2 become increasingly commonplace, their sums insured tend to be higher. Typically needing good transport links, they are away from urban areas, and are less attractive for the single “walk-on” intruders looking to steal copper pipe or electrical cabling.

However, their exposure to group and organised crime activities requiring vehicle access is of genuine concern.

Travellers in the past have regularly camped on car parks or hard standing of such sites and despite leaving large quantities of waste, the loss potential is moderate providing they remain on the car park. However, as witnessed recently with a number of £1m+ loss potentials, the risk then expands exponentially if entry is made into the building, with an instant claim for squatter’s rights, requiring a court order and days/weeks to evict. In the recent example, the travellers were also selling the option to others to dump waste inside the building.

It is important to remember that the ability to lease or sell a property after an attack will be difficult and repairs, which could include reinstating the electrical or plumbing installation, will take time as would the removal of waste where the warehouse had been used for storage of contaminated waste materials.

Secure your perimetersLandlords have a range of considerations to make, with primary and secondary protection options on the table.

CCTV and Security Guarding can be effective in providing visual deterrent, automatic Police summons or other security response. However, the time to gain access is generally very short and it has been demonstrated that CCTV and guards are powerless to stop this. When additional resource has arrived, it is often too late. In most cases there are too many intruders for a local police response to handle and often the police stand back.

Against this form of crime, strong perimeter protection and limiting access into the building has to be the priority. Were CCTV to be installed (temporary or permanent) it would require compliance with BS8418 to gain any form of police response.

A full site perimeter assessment should be sought to identify the potential points of access. Fencing of substantial strength such as palisade fencing (providing the bolts are welded to prevent easy removal) will deter vehicle drive-through. Hoop barriers can also be effective providing they are professionally installed with sufficient strength and depth set into concrete

Raised bed landscaping can be considered beneficial as long as the bed is large and tall enough to prevent a 4x4 (with caravan) driving on and over. Once established with trees and heavier vegetation then this will be quite secure against this. Crossing over fields or other unmade land may also be a big deterrent but needs careful consideration. Building of trenches to stop vehicles can be used providing they are frequently inspected against refilling.

Valid entrance points are clearly a risk but can easily be managed through a number of options. Permanent solutions rather than concrete rings or blocks are preferred as they will be a positive feature for new tenants who also will be looking to secure their access points. A single pivoting/rising barrier is not considered sufficient to protect this area so solutions include rising bollards, powered sliding gates (where power can be isolated) and other road blocks (see following) can all be effective. However, if guards are present then under duress they have previously been forced to release the barrier. Any option to do this therefore should be disabled. Temporary blocks and rings can be moved (if 1 tonne) so these should be specified as 5 tonne, or “rings bolted within a ring” to be fully effective.

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Building SecurityFor the purpose of vehicle access/squatting, the assessment has to consider where access is possible into the building. There may be no perimeter protection or very little, so huge investment may be is required to address this. In this case, protecting the building access points is essential. Most logistics buildings have raised loading bays so cars, 4x4’s and vans won’t be able to access these points at least, or via single pedestrian doors. To gain access, then roller shutters or wide double leaf doors/gates are vulnerable. Rising bollards, road blocks or temporary blocks/rings can be utilised externally in front of shutters in the same manner as in the perimeter protection section above.

To also protect against theft, not occupation, intruder alarm protection will be required. The very large warehouse buildings will involve significant rental fees for temporary alarm systems (upwards of £300 per week) and therefore it may prove more cost effective to install a hard wired intruder alarm with adequate signalling. A Grade 2 alarm with Grade 3 signalling will typically be acceptable (such as BT Secure 3 or CSL G3 (or better). The insurers loss prevention engineer Surveyor will confirm if allowing electrical supplies to remain on is acceptable. Longer range beam detection may also control install costs. This must cover the warehouse at all entry points and be accessible areas of the offices.

SummaryA one size fits all solution is never possible and the focus should be around choosing the right combination of security options.

Primary Protection

1. Assess the site perimeter to protect against access by vehicles and create protection where weaknesses exist

2. Where no perimeter protection is feasible or (1) above cannot be solved, substantial protection over building access/entry points will be required

3. Inclusion of alarm protection to the building to protect against normal theft risks

Secondary Protection

4. Security guards/CCTV may be effective if physical security is good or detection of potential entry can be made quickly and with rapid confirmed police response enabled (i.e. before building entry is likely). Where guarding or CCTV is present, it would be wise for this to continue to be present but Primary Protection as above is still essential. In the case of alarm protection, if the surveyor is satisfied the guarding team will be 100% aware of any entry, this may not be essential

5. Good quality CCTV may assist in evidence against the perpetrators, but this is highly unlikely to recover any of the claims cost

For more information, please contact real.estate@aon.co.uk

Property Eye | Aon Risk Solutions | December 2016 8

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Smart buildings need smarter risk management

By any measurement, Smart Buildings (or Building Automation) are growing quickly. Various sources suggest the market is worth between $5.7bn and $7bn annually, with projected revenue growth of +30% on a compound annual basis over the next four to five years5. Adam Peckman, Global Practice Leader for Cyber Risk Consulting at Aon explains why landlords are increasingly concerned over cyber security.

Adam Peckman| Global Practice Leader, Aon UK

Typically defined as the automatic centralised control of a building’s heating, ventilation, air conditioning, lighting, security and lift operating systems; smart buildings are enabled by networked solutions that connect some or all of a building’s systems together.

Aon’s own headquarters at 122 Leadenhall Street falls squarely into the category, as do other developments in the UK real estate investment sector’s portfolio. For example, Land Securities’ 2013 reopening of the Trinity Leeds shopping centre included a networked infrastructure built by Cisco Systems connecting systems including video surveillance cameras; doors, escalators, customer information, and smartphone application interface software6.

Cyber securityWith connected and shared networks fundamentally changing the way our built environment is being used and operated, thoughts amongst landlords should simultaneously turn to cyber security.

While historically the highest profile cyber-attacks have impacted on the retail, travel, hospitality and financial services industries there is now increasing financial and reputational exposure for property owners, their tenants and stakeholders.

In 2013, researchers showed the potential vulnerabilities of a connected building when they successfully infiltrated the Australian headquarters of Google7. Meanwhile, sinister reports of hackers using a specialised search engine called Shodan which finds the IP addresses of web-connected devices, illustrate the open door left by some less secure systems8.

Increased reliance on IT solutions for building automation makes landlords potentially vulnerable to disruption on a number of levels,” he adds. “For example if hackers gain access to building management systems the property owner and tenants could experience all kinds of potential problems leading to property damage, personal injury, financial loss, business interruption and more”.

Links between building management systems and third party software have been identified as a primary route for cyber criminals to attempt access into hitherto secure networks.

A similar ‘angle of attack’ was found to be the cause of Target Corporation’s 2013 data breach in which a contractor was linked to the retailer’s electronic billing system9. There are many similarities between connected systems like these, and the ones used in a landlord/tenant context. Today’s real estate funds should consider their exposures carefully as standard insurance policy wordings may be insufficient.

If that weren’t encouragement enough, the pending European Union General Data Protection Regulation (EUGDPR) will create considerable obligations of its own. Intended to harmonise protection of personal data across Europe these will come into force on 25th May 2018 and require businesses to notify their local country regulator of any data breach within 72 hours and face fines of up to 4% of global revenue. The UK is likely to adopt a form of this legislation notwithstanding Brexit.

As the market invests more heavily in the technologies to support smart buildings, companies must conduct a thorough risk assessment to properly ascertain their own exposures at an enterprise level.

5 Sources: Smart Building Market by Building Automation Software Global Forecast 2021; Zion Research – Smart Building Forecast 2014-2020

6 Source: Cisco Systems Case Study; The Internet of Everything

7 Source: BBC News “Help, my building’s been hacked!”

8 Source: Forbes – The terrifying search engine that finds internet connected cameras, traffic lights, medical devices, baby monitors and power plants

9 Source: Wall Street Journal, 6th February 2014

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9 Source: Wall Street Journal, 6th February 2014

Within this assessment, should be the identification of credible cyber risk scenarios drawn from trigger event analysis (ie situations which could cause potential first and third party loss exposures).

Once this is properly understood, property owners can begin to model the potential quantum of financial exposure to cyber risk liability scenarios and differentiate between those risks which are insurable and those which can be retained.

It’s a rather blunt illustration, but what if a smart building’s lifts were to fail catastrophically? Does your existing property/casualty insurance programme pick up this type of risk when cyber breach is the proximate cause of loss?

For more information, please contactreal.estate@aon.co.uk

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Claims MI: From raw data to risk understanding

Historically the preserve of underwriters seeking a benchmark for renewal premiums, claims data often feels closed off to the wider risk management community. But is this practice ripe for change now that data capture, mobile applications and analytics have become more widely available? Dylan Allen explains.

Our experiences as consumers are increasingly dominated by technology and applications which allow us to influence the service we receive.

The apex in recent years has been labelled ‘uberisation’ or the ‘gig economy’ in which contractors are able to flex their services to meet consumer demand in a transparent marketplace. The result becomes a customer who truly feels at the centre of things.

Of course there is a huge difference between hailing a taxi and submitting claims information via an insurance programme. However, the possibilities to deploy technology in a service industry environment are now so well understood by the general public, it stands to reason that our customers may demand more online claims solutions from us in future.

The insurance sector is itself very good at capturing data forming the basics of a claim; what happened when, where, how much it is likely to cost and what the timeline to settlement will be. However this rarely places the customer in a central position and they will not always be able to use this data to influence their own total cost of risk (TCR).

Aon’s Real Estate clients receive detailed claims management information which collates numerous data sets and it is our intention to encourage much greater use of this information.

Many of our customers already use this management information (MI) in presentations at renewal and we are keen to encourage them to do this more. We believe that by utilising existing MI and constantly striving to increase the number of fields we can collect at the point of claim; the result can be a reduction in TCR.

Electronic claims notificationAon is now looking at technology that can help us drive this objective toward the next level.

Electronic claim notification tools through online apps enable claims to be recorded and

notified as they happen. The technology can be intuitive, leading the claimant through the process. Data fields can be made mandatory to ensure essential information is recorded. Systems can be pre-populated with information specific to the client’s property portfolio meaning that property and fund information can be selected and stored in a way that guarantees data integrity.

Sophisticated production tools can in turn take detailed claims data and turn it into useful and interactive MI, identifying common trends and risk issues at various levels; from individual properties through to geographical territories.

For example, escape of water claims are quite common and can occur in high volumes across the residential sector. Trend analysis could reveal numerous causation issues such as weather, wear and tear, poor maintenance or construction and installation defects. Elements of this can be captured on the electronic claims submission forms we are developing with our partners.

Targeted capital expenditureThe final piece in the puzzle is how to turn information into action through targeted capital expenditure. One established method in the Aon toolkit is risk management bursaries.

These take the form of a lump sum investment made by the insurer which provides a cost effective way to mitigate future claims; for example a water detection system installation to address the above issue.

Collaborations like these involving the client, insurer and broker in a tripartite group can only perform and improve with the right kind of intelligence at their core. We hope that by deploying tools which help property managers to notify claims in as much detail as possible, customers will be incentivised to put themselves at the centre of the process.

For more information, please contactreal.estate@aon.co.uk

Dylan Allen | Real Estate ClaimsDirector, Aon UK

Risk. Reinsurance. Human Resources.

About AonAon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 72,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: http://aon.mediaroom.com/

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Property Eye should not be construed as giving opinions, assessment of risks or advice of any kind (including but not limited to actuarial, re/insurance, tax, regulatory or legal advice). The content of Property Eye is made available without warranty of any kind and without any other assurance whatso-ever as to its suitability for any purpose, completeness or accuracy.

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