Terrorism insurance has been boring for the past several years. It risks becoming not boring. In the lee of the terrorism attack of 9/11, the Terrorism Risk Insurance Act, or TRIA, was rapidly passed by the Congress and signed by the President. TRIA provided a federal backstop for private terrorism insurance responding to the unwillingness of the private insurance market to provide meaningful terrorism insurance in light of the unpredictability of the risk and, therefore, perceived inability to price the insurance. TRIA was initially passed in November 2002 and reauthorized in 2005 and 2007. It expires on December 31, 2014. An extension is far from certain.
First, a quick primer on how this all works. TRIA requires property insurers to offer terrorism insurance coverage in a manner similar to the way other more traditional coverages are provided. In exchange, the government provides a re-insurance backstop in case of catastrophic loss. The mechanics are complicated but, essentially re-insurance kicks in for individual loss events greater than $100 million to the aggregate insurance industry after the insurance company kicks in a deductible based upon a percentage of its terrorism insurance direct premium income. It all caps out at a loss of $100 billion.
Ever since TRIA, our loan documents have generally required terrorism insurance. For those of you who don’t get that certain frisson of excitement for reading mortgage loan documents, you may not have actually memorized what our documents say about terrorism issues. A typical formulation looks something like this:
"insurance with respect to the Improvements and the Personal Property insuring against any peril now or hereafter included within the classification “All Risk” or “Special Perils” (including, without limitation, fire, lightning, windstorm, hail, terrorism and similar acts of sabotage, explosion, riot, riot attending a strike, civil commotion, vandalism, aircraft, vehicles and smoke), in each case (A) in an amount equal to 100% of the “Full Replacement Cost,”…"
In some, but not all cases, the following language may be found:
"Notwithstanding the foregoing sentence, Borrower shall not be obligated to expend more than [$___________] in any fiscal year on Insurance Premiums for Terrorism Insurance (the “Terrorism Insurance Cap”) and if the cost of the Terrorism Insurance Required Amount exceeds the Terrorism Insurance Cap, Borrower shall purchase the maximum amount of Terrorism Insurance available with funds equal to the Terrorism Insurance Cap; provided, however, in the event such Terrorism Insurance is customarily maintained by owners of [_______________] properties in the United States as part of the all risk coverage required pursuant to Section______ hereof, Borrower shall maintain such Terrorism Insurance as a part thereof, regardless of the cost of the related Insurance Premiums."
A bill was recently introduced by Congressman Grimm and others to reauthorize TRIA. The bill essentially extends the current program for five years without any material change. (Sidebar: How delightful to read Congressional work product that is only two pages long! There may be hope.) The politics of TRIA are complex and the dividing lines in the Congress and Senate do not run along traditional party lines. There is an element of the Republican party that says private enterprise should provide the solution, fullstop. The constituencies who understand the importance of TRIA to capital formation, as well as those who represent major urban centers which have been traditionally thought to be at particular risk of terrorism attack, support it voraciously. It’s very hard to tell at this stage whether reauthorization occurs, although policy wonks already seem to think that, at the end of the day, it will be.
As reauthorization began to creep into the collective conscience, more borrowers have begun to negotiate caps on the aggregate cost of terrorism insurance. Given uncertainty, it’s time to start thinking about risk with and without TRIA, or materially revised but with a totally different TRIA. Here is what we’re thinking:
• The coverage may get more expensive in the run-up to expiration; therefore, as a lender, consider pushing back on caps, and if you agree to cap coverage, make sure the cap makes sense both in the current environment and the run-up to reauthorization. As a borrower, run this paragraph backwards.
• As a lender, think about tying some aspects of loan document architecture to the presence or absence of coverage. Does the disappearance of the coverage trigger some sort of hyper-amortization or more rapid amortization to reduce LTVs? Might extension options be curtailed if coverage went away? I have some personal experience attempting to enforce terrorism insurance in a high premium environment, and I’m here to tell you the judiciary, broadly, is not going to be terribly sympathetic to an asserted event of default tied to the lack of terrorism insurance which is not commercially available at economically reasonable rates. As a lender, one would have to think twice about utilizing a breach of terrorism insurance coverage as a basis of an event of default. Better, perhaps, to think about other adjustments to the credit profile of the transaction in light of the deteriorated coverage.
• Consider tying some element of the coverage into recourse covenant.
• For issuers and underwriters, revisit risk factor disclosures, particularly for vulnerable properties such as large, standalone assets in major metropolitan area environments. Be crystal clear that terrorism insurance coverage at any level or at levels which are economically feasible might not be available 20 months from today.
If TRIA goes away, the private market will either be diminished or disappear entirely. That’s altogether possible. Several commentators have suggested that if TRIA goes away, there will be no terrorism insurance available from the private markets at all and, of course, at some level of pricing it becomes economically unfeasible in any event.
We’ve got some time here. This needs to get fixed. Other outcomes do not bear thinking about. We have a shot at bettering the odds by trying to effect policy. I would urge everyone to work with their trade organizations, CREFC, MBA, SIFMA, ASF, etc., (and, yes, contribute to their PACs) to ensure that the views of the industry are heard. Last time I was deeply involved in the TRIA Advocacy initiative, it was frustrating to see that many in Congress viewed this as an insurance company issue with the greedy insurance companies attempting to shift risk to the federal government. We in the commercial real estate industry shouted (but were not heard) “It’s not about them, it’s all about us!” This insurance is necessary for successful capital formation in commercial real estate. It’s not about the insurers. They will happily stop offering coverage without TRIA. It is commercial real estate that will take it on the chin.
We never really succeeded in changing the shape of the debate. We need to frame the debate early and forcefully. We need to make sure our Congressmen and Senators understand that the TRIA backstop is all about protecting the viability of the commercial real estate finance marketplace. As the Grimm Bill progresses this year (that just doesn’t sound right, does it?), or as other legislative efforts are undertaken between now and its expiration, our duly elected leaders need to understand that this is a reasonable governmental function to meet a need which cannot otherwise be met in the private marketplace, and which is critically important to capital formation.