E-Mail: OmegaRM@optonline.net

This paper was prepared for presentation at The New York State Bar Association-Real Property Section, Annual Meeting in New York, January 24, 2002 and updated on February 5, 2002 for publication in the New York Law Journal

On September 11, 2001, the United States was the target of an attack that in less than two hours resulted in the largest single insurable loss in recent times. This horrific event has changed our world and that of the insurance industry. Currently the debate rages over such issues as the adequacy of insurable values, the number of terrorist acts on 9/11, the reserving practices of insurance and reinsurance companies, and whether insurers and reinsurers will be able to meet their financial obligations to policyholders and each other. The impact will be felt for years to come as underwriters and legal experts define the rules and regulations required for terrorist coverage.

When more than 50 percent of reinsurance treaties expired on January 1, 2002, Congress had not yet agreed on legislative measures to cap insurer and reinsurer liability through some type of risk-sharing vehicle. The insurance industry has said its ability to continue to provide coverage for the terrorist peril as provided in policies in effect on 9/11 is limited and is lobbying to have the government provide a back stop to its liability should another unthinkable disaster reoccur.

This article focuses on property and business income insurance coverage issues solely as a result of the terrorist attack on the World Trade Center (WTC). All losses from the terrorist attack are estimated to be $50 billion. While many of the issues reviewed in this article may be applicable to any property loss; the emphasis is on loss caused by terrorist acts.

Most property insurance policies exclude losses from declared war or losses caused by a uniformed invasion force or sovereign power. The event that befell the World Trade Center (WTC) was neither. That is, it was not caused by a sovereign power, a uniformed invasion force nor an act of declared war. Thus, in the absence of a policy term, condition or exclusion that limits or prevents coverage response, the Special Form (aka: so called "All-Risk") policy pays the loss.

Was the occurrence two hijacked aircraft each crashing into one WTC tower or was the occurrence one terrorist plot that destroyed the WTC towers? The answer, pending a decision by the U.S. District Court for the Southern District of New York, will have a significant outcome. If the decision is one occurrence, insurers will be liable for the occurrence limit in their policy, which is reported to be approximately $3.6 billion. If the decision is two occurrences, the insurers liability would double to approximately $7.2 billion.

The damage around the towers caused by falling debris was substantial. Those buildings directly damaged likely will be covered for physical restoration expense (replacement cost) and loss of business income/rental income until the premises are "with due diligence and dispatch" restored to a condition that existed prior to the loss. Those properties not physically damaged, but barred from use during the period following the attack will likely have their loss of business income limited to a sub-limit. Most property insurance policies limit coverage to two weeks for prevention of ingress and egress. While longer periods and sub-limits for overall loss on a portfolio of buildings has been observed, the most common coverage extension is two weeks.

Firms with business income coverage may have funds available to continue their operations at a new location. Coverage for the additional expense of doing business over and above normal operating expenses can be insured by the inclusion of an extra expense endorsement.. The contingent business interruption endorsement may also cover business interruption loss if an existing supplier or customer is unable to conduct business with the insured firm.

Some types of insurance coverage affected by the 9/11 attacks include the following:

• Property and Business Income coverage for direct damage to the towers caused by the impact of the aircraft and the resultant rain of debris on buildings in the surrounding area.
• Worker’s Compensation coverage for employees injured in the attack.
• Life Insurance payments to beneficiaries.
• Disability insurance coverage for those unable to work following the events of 9/11.
• Public Liability coverage for such things as failure to provide adequate security or evacuation instructions.
• Aviation Insurance to cover both the loss of life and loss of the aircraft.
• Director’s and Officer’s Liability coverage for ensuing law suits due to inadequate insurance or failure to provide adequate measures to assure continued business operations.

Property insurance policies provide coverage for loss of property and are extended by endorsement to cover loss of business income. Most business policies contain a menu of coverage and include some or all of the following:

Property insurance policies pay a limit of insurance on a per occurrence basis. Other conditions that will determine how a loss is paid and on what terms, includes replacement cost or actual cash value, application of co-insurance penalties and imposition of sub limits and other terms and conditions that would potentially limit a policy response.

Business and Rental Interruption Insurance are endorsements to the property insurance policy and provides the insured with indemnification for lost net profit and continuing fixed expenses from the time of the occurrences, until, using "due diligence and dispatch" the premises can be restored to a condition that existed prior to loss. Given that the time necessary to reconstruct the WTC has been estimated as much as five years, the necessary limits of insurance should be adequate to cover this time period.

Extended Period of Indemnity allows the landlord additional time to find tenants. By the time reconstruction is complete it is likely that most, if not all, tenants in the damaged and destroyed buildings will have found other space. When the premises are ready to be re-leased, indemnity under the Business Interruption or Rental Income coverage ends unless an Extended Period of Indemnity Endorsement has been added to the business interruption and rental income coverage. The Extended Period of Indemnity Endorsement is purchased in 30 days increments. Most purchasers select a 180- or 360-day indemnity period. Coverage may be purchased for longer periods, however more than two years is rare.

Extra Expense Endorsement is an extension that pays for additional costs to the insured to continue operations as near normal as possible to those existing prior to loss. Extra Expense coverage is available under the Business Interruption & Rent Loss coverage forms (dollar for dollar) to the extent that the payment reduces the business or rental income loss under the coverage part. A separate Extra Expense Endorsement can provide coverage for sums in excess of those saved under the Business Interruption and Rents form. Thus, if it costs a policyholder $1.25 to save $1.00 in lost business income, the additional 25¢ is paid by the Extra Expense Endorsement.

While the loss of the towers and their replacement is the basis of direct property damage and business income, other losses covered in less obvious policy extensions and special endorsements may be of greater significance. Some examples include:

The inaccessibility to lower Manhattan (below 14^th Street) made it impossible to gain access to buildings and business establishments for nearly two weeks, and in many cases longer. Prevention of Ingress and Egress & Act Of Civil Authority is an extension of coverage is found in nearly all property insurance policies; however, coverage is usually limited to two weeks. Some savvy corporate risk managers have been able to negotiate longer periods and/or sub-limits for groups of buildings.

Contingent Business Interruption endorsement pays the insured’s business interruption loss if the damage is of the type insured in the policy and prevents the insured from doing business due to loss at a customer or a supplier location. Service providers, such as restaurants and hotels, rarely purchase this type of coverage.

A significant extension of coverage for rebuilding the destroyed towers is "Law and Ordinance", aka: "Demolition and Increased Cost of Construction" (D&ICC). This endorsement covers increased construction costs due to the enforcement of laws requiring that buildings be reconstructed to higher standards than those that existed at the time of loss. This coverage usually is subject to a sub limit.

A debris removal clause is a sub limit that could affect the availability of funds to reconstruct the WTC.. This clause, contained in most policies, has a sub limit equal to 10 percent of the policy limit. This is an additional amount of insurance and should the clean up exceed this limit the cost to remove the debris would come from the reconstruction fund, thereby leaving a potential shortfall.

Loss of business income caused by lack of utility service is another cause of ongoing business interruption. "Off Premises Service Interruption" is an endorsement that can cover this, however it has many variations, including: the number and type of utilities covered; whether the utilities are public or private; insurable perils; and the distance of the damaged utilities from the premises to which the coverage responds.

A tenant can insure the financial loss associated with termination of a favorable lease through the purchase of leasehold interest insurance. This endorsement pays the tenant if a loss destroys their premises and the lease is cancelled by its terms. The amount insured is the difference between the remaining lease payments and the market rental today to replace the space destroyed, through the remaining term and renewal option periods, discounted to present value.

Exclusions that are the focus of attention with regard to insurance coverage for future terrorist acts involve the following:

• Declared war is excluded from coverage in most policies.
• Terrorist acts are covered by an exception to the exclusion: the terrorist act must typically be caused by a sovereign power or uniformed invasion force to be excluded.

The following is an example of a Pre 9/11 Terrorist Exclusion. Note the condition in which the exclusion applies and the exception to the exclusion.

Item iii of this exclusion does not apply to physical loss or damage insured by this Policy done by terrorists or done secretly by a foreign enemy or agent of any government or sovereign power (de jure or de facto), when not in connection with the operations of armed forces in or against the country where the Insured Location is situated.

The Insurance Services Office (ISO), a service arm of insurance companies, has filed a new Terrorist coverage endorsement in more than 40 States. The New Terrorist Coverage is complex and limits the insurance industry exposure to catastrophic loss by redefining occurrence and limiting loss for all insured losses regardless of the number of policies involved.

Some States have accepted the new endorsement with reservation and others, including New York and California, have rejected the filing. The new ISO endorsement is a departure from traditional insurance and requires review to gain an understanding of the coverage.

When the total of all insured losses reach a threshold of $25 million per incident all coverage is cancelled and void. This includes direct damage, resulting business income, prevention of access and other extensions as well. An incident (not the customary occurrence) is redefined as all insured losses, within the United States and Canada, that occur within a 72-hour period and appear to emanate from a common source are one occurrence. In addition coverage is not provided for loss due to nuclear, chemical or biological loss or damage. Liability forms reportedly contain similar clauses and add the coverage canceling condition should the incident cause the death of 50 or more people.

Web sites with general information regarding the National Association of Insurance Commissioners (NAIC) and the details regarding the policy forms and State filing are as follows:

National Association of Insurance Commissioners (see 12/21/01 Press Release)

http://www.naic.org/

Independent Insurance Agents of America-policy form

http://vu.iiaa.net/library/Insurance/CL/Property/Articles/LibraryInsuranceCLPropertyArticlesTerrorismExclusions01.htm

Insurance Services Office-State filings

http://www.iso.com/filings/update.htm

This section covers the state of the insurance market Pre- and Post- September 11, 2001.

Prior to 9/11, the world insurance markets were in the process of rebounding from one of the longest soft insurance markets in history. The competitive pricing of various insurance products in recent years lowered rates to levels never seen before. Premium increases in the year preceding 9/11 marked the beginning of insurers’ efforts to once again become profitable and 9/11 was a major disruption to that attempted recovery.

Post 9/11, many property insurance renewals are experiencing significant rate increases ranging from 20 percent and in some cases more than 400 percent. In addition, insurance coverage is being reduced and features such as Blanket Limits of Liability and Terrorist Coverage are difficult, if not impossible, to obtain.

In the months following 9/11, the chief executive officers of A I G and Travelers Insurance companies have discussed the need for a Federal back stop or a reinsurance arrangement. They propose the government provide coverage for 90 percent of the loss in excess of the first $10 billion in losses caused by terrorist acts. They noted that the insurance industry has a capacity to absorb at most $130 billion and that exposure to yet a second loss of the magnitude of the WTC would have serious effects on the industry. Warren Buffet, chairman of Berkshire Hathaway, proposed an FDIC-type system to provide a vehicle to fund and share risk among all commercial insured.

Reinsurers have refused to provide unlimited terrorist coverage to retail insurance companies. What action is left for retail insurers who will not take on more risk than their in-house capacity (the amount they keep without the benefit of reinsurance)? The answer is to reduce the overall policy limit to the amount of terrorist coverage they are willing to underwrite. This creates an overall capacity shortage, which drives rates up dramatically, and limits the coverage extensions afforded to policyholders. One example is the reduction or elimination of Blanket Limits; a coverage enhancement often afforded the insured’s. Capacity is the available amount of coverage. Lower supply and higher demand result in dramatic premium increases for the insurance buying public.

Generally, lenders can be expected to be very cautious. They will demand copies of the actual insurance policies and will likely insist on terrorist insurance coverage on larger well-known buildings.

Some lenders are already taking a position that the lack of terrorist insurance is an increased hazard and may be an acceptable risk if borrowers pay additional fees for their loans. Other lenders will require remotely located additional collateral or personal guarantees from the borrower’s principals.

According to agencies like Standard & Poor’s (S&P) that rate commercial mortgage-backed securities (CMBS), many are evaluating the exposure and need for coverage on a case-by-case basis. Large target properties in major cities will likely be required to provide terrorist coverage while a strip shopping center in a rural area will likely not be required to have terrorist coverage. S&P may in some cases accept a terrorist exclusion and will likely add a notation or subscript to the security listing that coverage is not provided.

While the insurance industry and legislators continue to search for a workable solution to cover terrorist attacks, failure to find an acceptable risk-sharing partner, even if only temporary, will continue to raise premium levels and restrict coverage. Presently, insurance for terrorist risk is available at substantial cost on a restricted basis. One broker noted that in a recent placement on a $200 million insurable value building in Europe, the additional cost to add terrorist coverage was $1 million.

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James Branigan is president & CEO of Omega Risk Management LLC. His firm provides insurance consulting services to corporations and conducts due diligence reviews for financial institutions originating large commercial loans throughout the United States and Canada. Mr. Branigan has written several papers on insurance in real estate finance for the Practiseing Law Institute (PLI) and co-authored a chapter on insurance in the Commercial Leasing book that will be published by the New York State Bar Association later this year. He has served on the PLI Faculty for three years, been a speaker for the NYS Bar Committee on Leasing and was a panelist on insurance in commercial leasing for the NYC Dirt Lawyers. His most recent presentation was before the NYS Bar Association-Real Property Section annual meeting. Mr. Branigan has delivered numerous insurance training sessions for commercial lenders and law firms throughout the U.S.

Mr. Branigan attended the City and State University of NY where he studied Fire Science and Business. He is licensed as an Insurance Broker and Insurance Consultant by the State of New York and served in the United States Navy.

James Branigan can be contacted at 631/692-9866 or omegarm@optonline.net