Moody's Developes New Framework For Evaluating Terrorism Insurance Coverage Issues In U.S. CMBS Deals
March 5, 2002
New York, -- In the wake of the September 11 terrorist attacks in the US, Moody's Investors Service has taken steps to implement a new framework for evaluating the affect on ratings that the lack of or limited terrorism insurance coverage may have for building loans that are part of US commercial mortgage-backed securities (CMBS) deals.
The rating agency said that it is not considering any downgrades in the next few months of any existing deals while it continues to evaluate the political and insurance industry responses to the availability and cost of terrorism insurance.
"In the intermediate term, however, we will be looking closely at a limited number of high-profile buildings to determine what affect a lack of terrorism insurance may have on ratings," said Moody's analyst Daniel B. Rubock, lead author of the report titled "Moody's Approach to Terrorism Insurance for U.S. Commercial Real Estate."
Deals coming to market will now be evaluated using Moody's new framework, which in essence judges a building's relative likelihood of being a terrorist target and, secondly, measures the diversity of buildings within a particular CMBS deal's pool of loans.
In its simplest form, the new framework consists of placing buildings within CMBS deals on a grid, with one axis of the grid reflecting a building's prominence and the other axis reflecting the diversification of commercial real estate within the particular CMBS deal.
Trophy buildings are considered Asset Tier 1, along with buildings in close proximity to them. Asset Tier 2 consists, for instance, of large Class A or Class B buildings in a city's central business district, or super-regional shopping malls. Asset Tier 3 are smaller buildings that populate most US CMBS deals, Rubock said.
The grid's other axis, the pooling tier, is also divided into three categories and identifies the diversity of buildings within the CMBS transactions because "diversification is a key ingredient in reducing the impact of a lack of or limited terrorism insurance," Rubock said.
Deals will be judged to be in Pooling Tier 1 if they are single assets; in Pooling Tier 2 if they contain many large loans averaging, for example, $75 million to $200 million or more; and in Pooling Tier 3 when there are a large number of similar, average commercial properties.
Once classified on the grid, many other factors will come into the evaluation process, including the level of terrorism insurance obtained (if any), the security procedures at the facility, the legal language in the mortgage requiring terrorism insurance, the identity of the tenants, the quality and type of construction, but "each asset will be considered on a case-by-case basis," said Tad Philipp, Moody's managing director for CMBS and co-author of the report.
The issue of terrorism insurance became acute after January 1, 2002, when reportedly 70% of the reinsurance "treaties" expired. "This created a domino effect to primary insurers, and they stopped or threatened to stop offering terrorism coverage for certain types of properties," Rubock said.
Because terrorism acts were not specifically excluded from all-risk policies before September 11th, the resulting damage was covered automatically. The primary insurers and their reinsurers affirmed coverage for the attacks, and despite some initial fears, did not cite the war risk exclusion, the analyst said.
Current estimates of property damage and business interruption losses from the World Trade Center attacks exceed $25 billion.
"The magnitude of losses triggered soul- and purse-searching by primary insurers and their reinsurers about their exposure to the actuarially intractable risk of terrorist attacks, and reinsurers felt that such risks could not be reliably calculated," Rubock said.
Insurance Still Available To Some, But At A Cost
The current availability and cost of insurance coverage depends on the building. "For large, trophy buildings, and for office towers of over 50 stories in central business districts, terrorism coverage generally is very difficult to obtain; and if available, it is almost prohibitively expensive," Philipp said.
"However," the analyst continued, "some primary insurers are still offering property and casualty insurance without exclusion for terrorist acts on a variety of commercial properties, although with significantly reduced coverage limits, higher deductibles, and at substantially increased rates."
At this time, only a handful of primary carriers are writing terrorism coverage, and the maximum primary insurance amounts available tend to be in a range of $75 million to $100 million, so "layering" is required for very large commercial mortgage loans, Rubock said.
Some insurers that are writing terrorism coverage are only willing to do so for existing customers. Most that are issuing stand-alone excess coverage (starting only after primary coverage is exhausted at about $100 million) are writing coverage to a maximum of an additional $200 million. However, policies differ on how terrorism itself is defined, what types of terrorist activities are covered, and whether all terrorist activities below a certain dollar threshold are covered even if otherwise they would be excluded.
"Terrorism is hard to define, and some definitions of it are over-broad," Rubock said, adding "if the primary insurance policy says one thing in its exclusion, and the stand alone terrorism policy issued by a second insurer defines terrorism differently, this may be major grounds for dispute if a terrorism event occurs."