A Primer on Terrorism Insurance

Terrorism exclusion clauses deny coverage for events considered by the federal government to be “terrorist acts.” In response to the widespread exclusion of this risk, Congress passed TRIA in November 2002, ensuring that businesses would be provided with terrorism insurance at reasonable rates. TRIA also gave the insurance industry time to stabilize after paying out close to $40 billion in losses following the 9/11 attacks. Under TRIA, insurance agreements that contain exclusionary clauses for terrorist attacks are void for the duration of the federal program, which will expire at the end of this year.

The U.S. Treasury TRIA Assessment

On June 30, 2005, the Treasury Department issued an assessment of TRIA. The Treasury's report highlighted the successes of the program, but ultimately did not recommend an extension of TRIA, concluding that a continuation of the program would only lead to a hindrance of the insurance industry's innovation and capacity building. (Letter from John Snow, U.S. Treasury Secretary, to Michael Oxley of the House of Representatives, (June 30, 2005)). The report notes that nonresidential building and commercial office construction is a small sector of the national gross domestic product and large measures to combat weaknesses in that sector will not be effective. The Treasury Assessment Report predicts, “[t]he immediate effect of the removal of the TRIA subsidy is likely to be less terrorism insurance written by insurers, higher prices and lower policyholder take-up. (United States Department of the Treasury, Report to Congress Assessment: The Terrorism Risk Insurance Act of 2002, pg. 134, June 30, 2005 at: www.treas.gov/press/releases/js2618.htm.) Over time, [the Treasury] expect[s] that the private market will develop additional terrorism insurance capacity.”

Currently, most insurance policies have terrorism coverage as required by TRIA, but, generally, such coverage will expire with the termination of TRIA. The Treasury foresees that property owners in high-risk areas will react by seeking to mitigate their risk and thereby lower insurance costs. For example, a manufacturing plant and/or office building might relocate from a major metropolitan city or other high-risk zone in order to lower the cost of its insurance. These kinds of measures may seem extreme, but they may become a reality of nonresidential building projects after the termination of TRIA.

Proponents of extending TRIA include real estate companies, private insurers and some elected officials. Their main argument is that terrorism coverage will be close to impossible to obtain after the termination of the program and may lead to building construction delays similar to those seen after 9/11. (Raymond Hernan-dez, Congress Urged to Extend Help After Attacks, N.Y. TIMES, July 11, 2005 at C1.)

If, as it appears, TRIA is not extended, lenders and borrowers may again be faced with issues relating to the requirement that terrorism insurance be maintained.

Illustrative Cases

Various courts have grappled with the question of whether insurance requirements contained in loan agreements mandate the maintenance of terrorism insurance. In Omni Berkshire Corp. v. Wells Fargo Bank N.A., 307 F. Supp. 534 (S.D.N.Y. 2004), the loan agreement required the borrower (“Omni”) to maintain “comprehensive all risk insurance” on five secured hotels and “such other reasonable insurance” as the lender may “reasonably request.” When the loan agreement was entered into, the all risk policy held by Omni included acts of terrorism by virtue of its non-exclusion. (As the court pointedly noted, the term “all risk” is a misnomer, inasmuch as “all risk” policies do not cover all risks of loss, but only those risks which are not specifically excluded.)

Following 9/11, Omni renewed its “all risk” policy; however, the renewal policy contained an exclusion for acts of terrorism. Although Omni did not seek a policy that excluded terrorism coverage, when it sought to purchase insurance for the 2002-2003 term, all of the proposed policies were submitted with terrorism excluded. While terrorism insurance was available to Omni, it had to be obtained in the form of separate stand-alone policies with extremely high premiums.

The insurance policy ultimately procured by Omni was submitted to the loan servicer (“Wells Fargo”). Omni was then advised that its insurance was inadequate and that coverage for acts of terrorism must be procured. Omni refused to obtain such coverage and instituted suit against Wells Fargo, as the servicer of the loan, seeking a determination that Omni was not required under the loan agreement to obtain terrorism insurance.

After trial, the court concluded that Omni was required to purchase terrorism insurance, but not by virtue of the “all risk” clause in the insurance policy. In reaching its conclusion, the court noted that “all risk” insurance was not defined in the loan agreement and that there was no specific requirement that terrorism insurance be obtained in an “all risk” policy. The court observed that “all risk” insurance only means that there will be coverage for risks which are not specifically excluded and that, over time, the standards of the insurance industry have changed in this respect. Just as the industry raised exclusions for “Y2K” problems and mold, after 9/11, the industry excluded acts of terrorism.

The court in Omni noted further that although the insurance policy in effect at the time the loan agreement was entered into did not exclude acts of terrorism, subsequent policies did and that the loan agreement did not require Omni to maintain the same extent of “all risk” insurance present at the time of the loan agreement for the life of the loan. The court suggested that had the parties intended such an obligation, the loan agreement would have qualified the requirement of maintaining “all risk” insurance to be in the same form as existed at the inception of the loan.

While the court found that Omni was not required to maintain terrorism insurance by virtue of the requirement that “all risk” insurance be maintained, it did rule that the “other insurance” clause mandated such insurance, finding that Wells Fargo acted reasonably in requiring Omni to obtain, as “other reasonable insurance,” terrorism coverage. The court found that Wells Fargo's concern that Omni's hotels were at risk was unfortunately reasonable, ob-serving that a hotel was destroyed on 9/11 and that Omni's hotels are located in major metropolitan areas where there is some risk of an attack. The court also noted that owners of many hotels and other commercial properties have purchased terrorism insurance and that the cost for such coverage is reasonable. (Whether this final conclusion of reasonable cost will remain if TRIA is not extended, remains to be seen.) In the words of the court: “The short answer is simply that in the post-9/11 world when so much more is at risk, it was reasonable for Wells Fargo to request, on behalf of its certificate holders, that Omni provide an additional $60 million in insurance coverage to account for the loss of terrorism coverage created when the insurance industry decided to exclude terrorism from all risk policies.”

Shortly after the decision in Omni, a trial court in New York followed suit in BFP 245 Park Co. LLC v. GMAC Commercial Mortgage Corporation, 2004 WL 3030226 (N.Y. Sup.). Unlike the loan agreement in Omni, the loan agreement in BFP 245 Park contained the requirement that the borrower buy insurance “against any peril now or hereafter included within the classification 'All Risk'” as well as “such other insurance as the lender may reasonably request.”

In BFP 245 Park Co., the borrower brought an action seeking a declaration that its loan agreement did not obligate it to obtain and maintain terrorism insurance. The court ruled that the policy in effect at the time of the loan (March 2001) did not exclude acts of terrorism and that, under the terms of the loan agreement, the borrower was obligated to maintain terrorism insurance throughout the term of the loan. The court concluded that the loan agreement showed that the parties considered that an “all risk” policy would vary over time and that the parties provided additional language in the loan agreement that the insurance would cover perils “now or hereafter included” within the classification of all risk. The court further noted that the “other insurance” clause would provide an additional basis to request terrorism insurance if the risk of terrorism had been excluded from the policy in existence at the time of the loan agreement. The court then granted summary judgment in favor of the lender declaring that the borrower is obligated to obtain and maintain terrorism insurance for the term of the loan. It left for later determination whether the premium price demanded by the lender for the insurance coverage was reasonable.

Conclusion

In the event TRIA sunsets, litigation over loan requirements for terrorism insurance may resurface. While the requirement of “all risk” insurance may not alone mandate terrorism insurance, the right of a lender reasonably to request other insurance should support the lender's request for terrorism insurance.

This article originally appeared in the New York Law Journal, an ALM publication.

The Terrorism Risk Insurance Act (“TRIA”), 15 USC '6701 et. seq., designed to make terrorism insurance readily available to property owners, is scheduled to sunset on Dec. 31, 2005. If the Act is not extended and the cost of terrorism insurance becomes prohibitive, lenders and borrowers may once again find themselves embroiled in controversy over the question of whether governing loan documents require such insurance.

TRIA

Prior to 9/11, terrorism insurance was typically issued without additional charge in about 70% of all insurance policies. (U.S. Department of the Treasury, Report to Congress Assess-ment: The Terrorism Risk Insurance Act of 2002, June 30, 2005.) By 2003, the number of insurance companies offering terrorism insurance at no cost dropped to slightly under 40%, as part of an industrywide effort to curtail terrorism coverage. After the events of 9/11, the National Council of Compensation Insurers recommended the use of blanket terrorism exclusions.

Terrorism exclusion clauses deny coverage for events considered by the federal government to be “terrorist acts.” In response to the widespread exclusion of this risk, Congress passed TRIA in November 2002, ensuring that businesses would be provided with terrorism insurance at reasonable rates. TRIA also gave the insurance industry time to stabilize after paying out close to $40 billion in losses following the 9/11 attacks. Under TRIA, insurance agreements that contain exclusionary clauses for terrorist attacks are void for the duration of the federal program, which will expire at the end of this year.

The U.S. Treasury TRIA Assessment

On June 30, 2005, the Treasury Department issued an assessment of TRIA. The Treasury's report highlighted the successes of the program, but ultimately did not recommend an extension of TRIA, concluding that a continuation of the program would only lead to a hindrance of the insurance industry's innovation and capacity building. (Letter from John Snow, U.S. Treasury Secretary, to Michael Oxley of the House of Representatives, (June 30, 2005)). The report notes that nonresidential building and commercial office construction is a small sector of the national gross domestic product and large measures to combat weaknesses in that sector will not be effective. The Treasury Assessment Report predicts, “[t]he immediate effect of the removal of the TRIA subsidy is likely to be less terrorism insurance written by insurers, higher prices and lower policyholder take-up. (United States Department of the Treasury, Report to Congress Assessment: The Terrorism Risk Insurance Act of 2002, pg. 134, June 30, 2005 at: www.treas.gov/press/releases/js2618.htm.) Over time, [the Treasury] expect[s] that the private market will develop additional terrorism insurance capacity.”

Currently, most insurance policies have terrorism coverage as required by TRIA, but, generally, such coverage will expire with the termination of TRIA. The Treasury foresees that property owners in high-risk areas will react by seeking to mitigate their risk and thereby lower insurance costs. For example, a manufacturing plant and/or office building might relocate from a major metropolitan city or other high-risk zone in order to lower the cost of its insurance. These kinds of measures may seem extreme, but they may become a reality of nonresidential building projects after the termination of TRIA.

Proponents of extending TRIA include real estate companies, private insurers and some elected officials. Their main argument is that terrorism coverage will be close to impossible to obtain after the termination of the program and may lead to building construction delays similar to those seen after 9/11. (Raymond Hernan-dez, Congress Urged to Extend Help After Attacks, N.Y. TIMES, July 11, 2005 at C1.)

If, as it appears, TRIA is not extended, lenders and borrowers may again be faced with issues relating to the requirement that terrorism insurance be maintained.

Illustrative Cases

Various courts have grappled with the question of whether insurance requirements contained in loan agreements mandate the maintenance of terrorism insurance. In Omni Berkshire Corp. v. Wells Fargo Bank N.A., 307 F. Supp. 534 (S.D.N.Y. 2004), the loan agreement required the borrower (“Omni”) to maintain “comprehensive all risk insurance” on five secured hotels and “such other reasonable insurance” as the lender may “reasonably request.” When the loan agreement was entered into, the all risk policy held by Omni included acts of terrorism by virtue of its non-exclusion. (As the court pointedly noted, the term “all risk” is a misnomer, inasmuch as “all risk” policies do not cover all risks of loss, but only those risks which are not specifically excluded.)

Following 9/11, Omni renewed its “all risk” policy; however, the renewal policy contained an exclusion for acts of terrorism. Although Omni did not seek a policy that excluded terrorism coverage, when it sought to purchase insurance for the 2002-2003 term, all of the proposed policies were submitted with terrorism excluded. While terrorism insurance was available to Omni, it had to be obtained in the form of separate stand-alone policies with extremely high premiums.

The insurance policy ultimately procured by Omni was submitted to the loan servicer (“Wells Fargo”). Omni was then advised that its insurance was inadequate and that coverage for acts of terrorism must be procured. Omni refused to obtain such coverage and instituted suit against Wells Fargo, as the servicer of the loan, seeking a determination that Omni was not required under the loan agreement to obtain terrorism insurance.

After trial, the court concluded that Omni was required to purchase terrorism insurance, but not by virtue of the “all risk” clause in the insurance policy. In reaching its conclusion, the court noted that “all risk” insurance was not defined in the loan agreement and that there was no specific requirement that terrorism insurance be obtained in an “all risk” policy. The court observed that “all risk” insurance only means that there will be coverage for risks which are not specifically excluded and that, over time, the standards of the insurance industry have changed in this respect. Just as the industry raised exclusions for “Y2K” problems and mold, after 9/11, the industry excluded acts of terrorism.

The court in Omni noted further that although the insurance policy in effect at the time the loan agreement was entered into did not exclude acts of terrorism, subsequent policies did and that the loan agreement did not require Omni to maintain the same extent of “all risk” insurance present at the time of the loan agreement for the life of the loan. The court suggested that had the parties intended such an obligation, the loan agreement would have qualified the requirement of maintaining “all risk” insurance to be in the same form as existed at the inception of the loan.

While the court found that Omni was not required to maintain terrorism insurance by virtue of the requirement that “all risk” insurance be maintained, it did rule that the “other insurance” clause mandated such insurance, finding that Wells Fargo acted reasonably in requiring Omni to obtain, as “other reasonable insurance,” terrorism coverage. The court found that Wells Fargo's concern that Omni's hotels were at risk was unfortunately reasonable, ob-serving that a hotel was destroyed on 9/11 and that Omni's hotels are located in major metropolitan areas where there is some risk of an attack. The court also noted that owners of many hotels and other commercial properties have purchased terrorism insurance and that the cost for such coverage is reasonable. (Whether this final conclusion of reasonable cost will remain if TRIA is not extended, remains to be seen.) In the words of the court: “The short answer is simply that in the post-9/11 world when so much more is at risk, it was reasonable for Wells Fargo to request, on behalf of its certificate holders, that Omni provide an additional $60 million in insurance coverage to account for the loss of terrorism coverage created when the insurance industry decided to exclude terrorism from all risk policies.”

Shortly after the decision in Omni, a trial court in New York followed suit in BFP 245 Park Co. LLC v. GMAC Commercial Mortgage Corporation, 2004 WL 3030226 (N.Y. Sup.). Unlike the loan agreement in Omni, the loan agreement in BFP 245 Park contained the requirement that the borrower buy insurance “against any peril now or hereafter included within the classification 'All Risk'” as well as “such other insurance as the lender may reasonably request.”

In BFP 245 Park Co., the borrower brought an action seeking a declaration that its loan agreement did not obligate it to obtain and maintain terrorism insurance. The court ruled that the policy in effect at the time of the loan (March 2001) did not exclude acts of terrorism and that, under the terms of the loan agreement, the borrower was obligated to maintain terrorism insurance throughout the term of the loan. The court concluded that the loan agreement showed that the parties considered that an “all risk” policy would vary over time and that the parties provided additional language in the loan agreement that the insurance would cover perils “now or hereafter included” within the classification of all risk. The court further noted that the “other insurance” clause would provide an additional basis to request terrorism insurance if the risk of terrorism had been excluded from the policy in existence at the time of the loan agreement. The court then granted summary judgment in favor of the lender declaring that the borrower is obligated to obtain and maintain terrorism insurance for the term of the loan. It left for later determination whether the premium price demanded by the lender for the insurance coverage was reasonable.

Conclusion

In the event TRIA sunsets, litigation over loan requirements for terrorism insurance may resurface. While the requirement of “all risk” insurance may not alone mandate terrorism insurance, the right of a lender reasonably to request other insurance should support the lender's request for terrorism insurance.

This article originally appeared in the New York Law Journal, an ALM publication.