Terrorism Insurance Alert

By Fred L. Pillon and Kristin Buff

"Many tenders have created rough guidelines for assesssing risk and determining which investments to pursue."

Prior to September 11, 2001, standard property insurance policies included full coverage for losses produced by terrorist events, under the assumption that the United States was an unlikely target. The radical change in risk calculus brought on by the events of September 11 has caused insurance providers to limit or entirely exclude losses caused by terrorist acts from coverage. With increased risk to their investments, many lenders now require commercial real estate borrowers to obtain terrorism insurance. Limited capacity to insure, increased demand for insurance and exorbitant costs combine to create uncertainty and uninsured risks - characteristics that threaten commercial real estate investments individually and liquidity in the real estate market in general. A recent survey conducted by the Mortgage Bankers Association of America found that thus far in 2002, inadequate terrorism coverage proved fatal to $3.7 billion in deals and detrimentally affected the timing and pricing of another $4.5 billion.

Early and decisive action by both Congress and the Senate raised hopes for a quick solution. However, differences between the House and Senate sponsored bills foreclosed the possibility of a reconciliation prior to the August recess. With Congress back in session on September 3, and President Bush's continued press for federal backstop legislation, movement towards a terrorism insurance bill appears to be gaining momentum.

Many lenders have created rough guidelines for assessing risk and determining which investments to pursue. One prominent lender employs a three-tiered system with Tier 1 presenting the highest level of risk and Tier 3 the lowest. Tier 1 consists of a very limited number of "trophy" assets that are well known regionally or nationally, and may also include buildings immediately surrounding trophy properties. Lenders are reluctant, and some flatly refuse, to enter bids to originate debt for properties in the first tier. Tier 2 assets are large, central business districts, major regional shopping malls and large multi-family residence buildings in major cities. Lenders demand some coverage for second-tier assets, depending on the specific risk factors the asset presents. Tier 3 assets include all properties not classified as Tier 1 or Tier 2 and are at little risk for terrorist...