Congress just gave banks a lump of coal for Christmas and it is not being received well. Last week the Senate failed to extend the Terrorism Risk Insurance Act (TRIA) which means that this December 31st will be the last day of coverage. This government-sponsored reinsurance program put in place after 9/11 allowed property owners and lenders to cover catastrophic losses (those above $100k) from an event of terrorism such as a bombing, biohazard attack or similar.
Without TRIA coverage, most insurers will not offer any coverage leaving the property owner and hence banks, at risk of exposure. For starters, all banks must be able to quantify the risk so that they know how many loans they have to deal with and what the overall risk exposure is. Banks with strong enterprise risk management systems will have this number already. Banks that don’t will now have to dig through loan files to try to ascertain how their loan documents are structured and what the risk of a non-covered terrorism-related event is.
In 2014, there were 10 terrorism-related attacks on US soil two of which caused material damage at bank financed real estate. While the two were under the TRIA coverage level, the 2013 Boston Marathon bombing in September of 2013 was the last event that caused material building damage to evoke the TRIA coverage. While the risk is remote, it is present and can leave the property owner and bank with a huge hole to fill in collateral value should an event occur in 2015.
How bank documents handle the expiration of the TRIA varies. Some commercial real estate loans have “sunset” clauses that automatically cancels all terrorism coverage in their insurance policy in their property’s coverage should TRIA be canceled. Additionally, some banks have their mortgage documents structured so that the borrower’s obligation gets automatically waived if TRIA is not available while some only allow that for certain borrowers or certain property types (usually those away from metro areas). In rare instances, some banks have a “Terrorism Premium Cap” that sets a maximum on what the borrower has to pay in order to now go out and get full terrorism coverage. Usually, this is 150% of the current insurance premium. Finally, many bank documents are silent on what happens when TRIA goes away and so banks have to now scramble trying to figure out a solution if they have not been tracking this already.
Thus, banks must ascertain what properties are exposed, what actions they have to take to mitigate the risk of the TRIA expiration and what actions the bank has to take in order to be compliant with their policies. Banks must determine if their forced placed insurance policies are applicable for terrorism insurance. If the bank is required to force place insurance, banks have to figure out if they are going to enforce the requirement for terrorism insurance or seek an exception.
The other thing that banks have to figure out is what will be done going forward. This will be a hot topic when Congress convenes on January 6th, but there is no telling how long a resolution on this issue may take or even if it gets resolved. Our guess is that it does get resolved as the measure should have bipartisan support but the timing is harder to estimate. As such, banks need to figure out if they are going to require terrorism going forward given the absence of the TRIA.
From a risk standpoint, it makes sense to gauge the risk on a property-by-property basis, so that metro properties, higher balanced loans and/or trophy properties would require terrorism coverage while other properties would not.
If your bank does not have documentary provisions for TRIA, it should, as it will prevent a similar scramble in the future if TRIA ultimately gets extended and then expires again. To help banks out, we have included our sample language HERE in our Resource Center for banks to reference with their counsel. Banks can adapt this language and hopefully strengthen their documents and flexibility. Then, banks need to track each loan for the type and structure of terrorism insurance and associated TRIA coverage.
Since most banks were betting on an easy extension, the expiration of TRIA has banks scrambling on how to handle the risk and related loan operation problems. Not an ideal Christmas present, but luckily not a huge risk in all probability. However, the issue raises the need for better loan tracking and more consistency in documents at many banks. If nothing else, this present will hopefully make banks better prepared for Christmases future.
Submitted by Chris Nichols on December 22, 2014