Score one for landlords. A New York appellate court has struck down a move by lenders who use the threat of default to force owners to purchase additional terrorism insurance for their buildings. While short of a decisive victory, the June ruling could help landlords in their efforts to avoid the costly — and, as some claim, unnecessary — coverage (see NREI, April 2003).

In the New York case, LaSalle National Bank and Cigna Investments had imposed $14 million in fees and interest on the Durst Organization for failing to buy adequate coverage on 4 Times Square, a 48-story office tower that is the headquarters of Conde Nast Publications. The dispute arose when Durst refused to pay premiums on a stand-alone terrorism policy on the building.

The appellate court's ruling limits Cigna and LaSalle from extracting any fees or penalties from Durst. A decision on the lenders' right to impose the policy awaits another trial, but Durst President Douglas Durst says the June ruling is encouraging.

Last fall's Terrorism Risk Insurance Act (TRIA) established a requirement that all insurers offer terrorism coverage to their property and casualty policyholders. Still, it didn't require that borrowers take out such coverage — and Moody's estimates that less than one-quarter of U.S. landlords have done so.

For buildings deemed unlikely terrorist targets, finding reasonably priced quotes is easy, says Christopher Yaure, director of specialty p&c for the Terrorism Coverage Unit of ACE USA. He pegs the cost at about 5% to 10% of total policy costs.

For moderate-risk properties such as those in prime business districts outside internationally famous cities, coverage can run about 12% to 16% of policy cost, says Yaure. But for those in high-risk areas, such as midtown Manhattan, landlords are being asked to pay huge sums. “We've seen terrorism coverage accounting for 50% or more of premiums in these cases,” he says.

At 4 Times Square, LaSalle and Cigna wanted Durst to purchase a policy priced at $4 million a year. The amount is 120% of the total cost of the previous all-risk policy for the 1.6 million sq. ft property, which excluded terrorism. The fee is roughly 5% of the building's annual revenue.

Douglas Durst says he doesn't oppose terrorism insurance per se, but objects to the exorbitant rate being charged, especially since his company obtained terrorism coverage with Lexington Insurance Co. for about $400,000 a year, one-tenth the cost of the lender-bought policy.

The lenders will not discuss the case, but they argue in court documents that their need to protect their investment overrides the landlord's objection to insurance cost. They assert the loan's requirement of full property and casualty coverage is inherently expandable: If federal law in effect defines coverage to include terrorism protection, so does the loan.

Gail Norstrom, managing director of Aon Risk Services in Chicago, acknowledges that many insurers still price terrorism policies too high. Why? Because there is no reinsurance market, and threat levels are hotly contested between properties. Unlike other threats to property, the likelihood of terrorist attack is hard to gauge. There have been no terrorist attacks on U.S. soil since 9-11. But that does not convince some insurers that the odds have changed. Meanwhile, the standoff between owners and lenders continues.

But Robert Vestewig, COO of loan servicer GEMSA Loan Services in Houston, figures that any borrower whose loan goes into the CMBS market will have to buy the coverage. “CMBS firms pretty much insist on it,” he says. “Portfolio lenders are more willing to look on a case-by-case basis.”

As more owners are forced to buy coverage, says Vestewig, a more rational approach to pricing will emerge. “At the moment, pricing seems to be somewhat arbitrary and it's not clear what the coverage actually provides,” he says. “But with experience, things should come more into line and people won't be so wary.”

Douglas Durst has a different take: “This litigation has created a life of its own, and we will never do business with Cigna again.”