It came close to the wire, but the president signed a two-year extension of the federal backstop for terrorism insurance on Dec. 22—a week before it was due to expire. After a brief sigh of relief, industry leaders quickly turned their attention to creating a permanent fix: The administration and Congress would prefer to get the federal government out of the business of guaranteeing insurance coverage for terrorist attacks on commercial real estate, but insurers, property owners, investors and lenders are looking for a permanent federal role.
The basic situation has not changed much since 2002, when the Terrorism Risk Insurance Act of 2002 (TRIA) was passed. In the wake of 9/11, many insurers had dropped terrorism coverage, which raised the specter of possible default on scores of high-profile properties where lenders—and underwriters of CMBS products—insist on coverage. The Mortgage Bankers Association, lenders and property owners warned of a crisis in the real estate markets and Congress temporarily approved federal reinsurance against losses to terrorism of up to $100 billion.
Now, the clock is ticking against another deadline and the Commercial Mortgage Securities Association and other TRIA advocates are pushing to have a permanent reinsurance program in place by the end of 2007. “When you have all these commercial loans conditioned on the availability and purchase of terrorism coverage, (borrowers) need the certainty that they’re going to be able to buy it,” says Scott Sinder, general counsel for the Commercial Mortgage Securities Association in Washington, D.C. Whether affordable terrorism insurance will be available beyond 2007 depends on the efforts of lawmakers and various stakeholders attempting to forge a permanent reinsurance plan.
What would a permanent plan look like? Various national models for terrorism insurance already exist in the United Kingdom, Germany and other nations, where insurers rely on a government-administered pool of insurance capital to help cover losses due to terrorist acts.
Even if the United States establishes a pool to reimburse providers for terrorism losses, however, the insurance industry will still need government backing while the pool grows to a size large enough to replace the federal backstop, according to one insurance industry source. “Pooling is good for aggregating capital and allocating it, but pooling doesn’t create capital of the magnitude that would be required to replace the government’s backstop,” says Julie Rochman, a senior vice president at the American Insurance Association.
Other questions involve the specific coverage insurers would be required to offer—a national program has to make coverage available, but must be affordable, too, says Gail Davis, a senior vice president of the commercial/multifamily group at the Mortgage Bankers Association. “It needs to be comprehensive in nature, minimizing exclusions, and needs to result in terrorism insurance coverage that is available and affordable,” she says.
Much of the debate in the coming months will center on whether insurers will be compelled to offer terrorism coverage for nuclear, biological, chemical and radiological losses (NBCR). The insurance industry has long maintained that NBCR risks are uninsurable due to the nearly incalculable extent of potential losses. But Sinder of the CMSA says property owners would like to be able to insure against NBCR losses, calling that “one of the biggest gaps” in the current program.
The Terrorism Risk Insurance Extension Act directs the President’s Working Group on Financial Markets to report no later than Sept. 30 this year on the long-term availability and affordability of terrorism insurance with NBCR coverage, which is excluded from the current program. The group’s conclusions will weigh heavily in the establishment of any permanent program for terrorism insurance in the United States, so stakeholders are anxious to start a dialogue with the Working Group in hopes of shaping policy in 2008 and beyond.
So far, a majority of lawmakers have worked to reduce the tax payer’s role in backing terrorism insurance. The recent TRIA extension, for example, increased insurers’ exposure through higher deductibles and co-pays, and increased the dollar amount of insured losses required to trigger TRIA payouts from the previous level of $5 million in a single year to $50 million in 2006 and $100 million in 2007.
TRIA proponents fear that efforts to reduce the government’s involvement in terrorism insurance coverage could lead to the federal backstop being allowed to expire at the end of 2007, without the creation of a replacement program. If that happens, insurers likely will either raise premiums to inaccessible levels or cease to offer terrorism policies entirely, leaving property owners without coverage and creating havoc for borrowers and loan servicers.
“The challenge is to find a more broadly palatable solution that facilitates the development of more private marketplace capacity to cover risks, and moves away from the current federal backstop construction,” Sinder says. “The time to start thinking about what happens next is now.”