Terrorism aftermath still haunts real estate market
Walt Tabler

Few would argue that the best insurance against terrorism is prevention. Almost as important as our efforts to pre-empt new terrorist strikes, however, is the challenge of insuring companies against the catastrophic financial losses that such attacks can produce.

Insurance works by carefully assessing and sharing risk, but the singular barbarity and future implications of Sept. 11 have thrown existing risk assessment notions into question. A year later, building owners, lenders, insurers, tenants — and the law — are still struggling to understand the risk inherent in large real estate transactions. They're scrutinizing existing and pending contracts, and reassessing their exposure, not just to terrorism, but to a spectrum of uninsured risks, from hazardous materials to mold. (That's right, mold. In Texas alone, there are an estimated $1 billion in mold claims pending).

Unless the risk can be managed, the insurance that makes development feasible may become unaffordable, or simply unavailable. So, some changes are already being implemented, and others are forthcoming. Meanwhile, there are important things all concerned parties can do to protect both their own and the public's interest.

High-profile, trophy buildings like the World Trade Center are now presumed to be at higher risk. How much higher? What attributes of existing or planned buildings increase this risk? Who should bear the cost of insuring against a disaster? The very rarity of terrorist attacks — the lack of predictive data — makes it very difficult to answer these questions. By comparison, insuring against loss from flood or earthquake is easy, in part because the probability of total loss is small, and because building modifications can further limit loss.

Lenders are concerned. Most financing for major projects is through "nonrecourse" loans — meaning the only thing a lender can do if the borrower defaults is take back the building. That's fine if there's a building left to take. In the wake of last September's attacks, lenders are looking for ways to force building owners to buy terrorism insurance. Results have been mixed, with legal difficulties depending on the latitude or ambiguity of existing contracts. In many cases, coverage simply isn't available.

For future contracts, some lenders will likely require terrorism insurance. Carve-outs (limits on coverage for terrorist acts) for nonrecourse loans may make it even more difficult for all but the most credit-worthy borrowers to secure financing — if they are willing to accept them. Securitization and diversification of pooled risk will be the norm. The pool of owners seen as qualified to develop projects may narrow.

Building owners will certainly face higher costs as a result of the uncertainty. They will likely bargain more aggressively for reasonable insurance requirements. The most fiscally sound companies (based on rating agency rankings) may get the most favorable treatment. Owners may consider securitization to keep higher costs in check, or simply pass them along to tenants. Smaller retailers and those renewing near-term leases will bear a disproportionate share of that cost. Buildings with higher risks could be at a real competitive disadvantage due to increased insurance costs.

Insurers' share of the risk may ultimately have to be borne through pricing based on aggregate exposure — charging every insured a higher rate to help protect the rare victim of attack.

Longer term, the most likely structural solution is to assign risk on a deal-by-deal basis, using carve-outs and requiring terrorist insurance, with rates based on factors such as building size, location, "symbolic value" and other factors.

For lenders, the safest course is to seek maximum portfolio diversity. Insurers, too, should continue to diversify, spreading their risk among different asset classes — being more selective in what they insure and how much exposure incur. For owners and developers, smaller projects may be in order for the foreseeable future, as financing of the next "Sears Tower" is probably insupportable, at least for now.

More than the size and location of buildings themselves is at issue. Companies are now paying closer attention to the concentration of various resources — human, data, communications, etc.

In this fluid environment, there are few certainties. Though presently ill-prepared to deal with the economic and legal ramifications of terrorist attacks, we have nevertheless begun the search for answers that, hopefully, will allow us to deal more quickly and systematically if future attacks occur, thus limiting their damage to the economy.

It would be folly to rely solely on government or any single institution to provide an easy bailout to the problems raised by terrorism. Real safety will only be found through all parties taking reasonable steps to protect their own interests, while maintaining a unified, principled stance against news risks, in accordance with the public good.

WALT TABLER chairs the real estate team at Graham & Dunn PC, a Seattle-based law firm. Reach Tabler at www.grahamdunn.com.