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For real estate interests this year, pushing Congress to renew the Terrorism Risk Insurance Act is the public policy question--no question about it.

If Congress renews the law, real estate will benefit from borrowing at better interest rates, which last year were still hovering at historic lows. Failure to renew the law could cost the industry billions of dollars as lenders further hike interest rates to cover the risk of lending to an industry exposed to catastrophic loss.

Eric Schake, a managing director in the national real estate practice of Marsh in New York, echoes the sentiment. "Terrorism is definitely the No. 1 concern for our clients," he says.

Before Sept. 11, 2001, there were no exclusions in insurance policies for terrorism. That changed after the attacks. "After Sept. 11, most insurance companies either left the market altogether or put a lot of restrictions and exclusions into their policies that rendered terrorism coverage very ineffective," says Martin L. DePoy, vice president, government relations, for NAREIT in Washington, D.C.

Consequently, after Sept. 11, the entire REIT industry suffered significantly from the lending community's position that required terrorism coverage. As borrowers, REITs scrambled to find the insurance coverage to meet the limits their lenders required.

That's when the federal government stepped in with TRIA, legislation that called for the government to pay 90 percent of insured losses after the deductible. TRIA had a major impact on the ability to locate terrorism coverage.

"TRIA is a partnership between the private sector and the federal government," says NAREIT's DePoy. "It provides federal reinsurance backstop against terrorism risk. It has been a success, and it has encouraged some insurance companies to come back into the marketplace and offer terrorism coverage."

However, the backstop is due to expire Dec. 31, 2005, which poses some new problems. And they're quite worrisome. "No one has yet stepped up to provide certified terrorism coverage on a reinsurance basis," says Marsh's Schake.

"We haven't seen any evidence that the private insurance market has shown the wherewithal to assume this risk again, because it is such a unique phenomenon," adds NAREIT's DePoy.Basically, there's been no indication that anyone is willing to step in and pick up the slack.

"We have not seen much evidence that the marketplace is ready to stand on its own two feet just yet," says Jay Hyde, vice president of communications for NAREIT. "We haven't seen reinsurers come back to this marketplace. They have no desire to do so, and without them, it makes it difficult for insurers to write policies that will stand up to this sort of threat."

As such, NAREIT is lobbying for an extension of TRIA through the end of 2007, which will give the market time to get back to where it was before Sept. 11, 2001, and give policymakers time to look at alternatives.

"Risk managers in our industry are liking the fact that the insurance market as a whole has turned softer," says Horvath. "However, if TRIA isn't renewed, this might have a negative effect on the softening market in general."

"We are going back to Congress to seek a two-year extension of TRIA," says DePoy. This is designed to have a two-fold effect. The first will be to calm some of the uncertainty in the marketplace. "Some companies have language in their policies that are being renewed stating that, if TRIA is not renewed, terrorism coverage will extend through the end of 2005, which is when TRIA ends, but not into 2006."

Second, the extension will allow Congress the time to debate and identify a long-term solution to this problem. "Options could include a pooling arrangement or other public-private partnerships," says DePoy.

The Coalition to Insure Against Terrorism, a 71-member group, has been carefully monitoring TRIA and is also pushing for its extension. NAREIT, along with other business organizations, created CIAT in early 2002 as a way to give policyholders a voice in the terrorism insurance coverage debate, in general, and TRIA, specifically.

Members include representatives from REITs, railroads, hospitality, major league sports, entertainment, manufacturing and banking. "We work with lawmakers to emphasize the importance of TRIA, its extension, and long-term solutions," says DePoy, who is also the spokesperson for CIAT.

It's going to be a difficult task, to be sure. "Overall, I think we will have an uphill battle this year trying to get an extension of TRIA, so I would encourage risk managers to be aggressive in contacting their lawmakers and expressing the need for a TRIA extension," adds DePoy.

In the meantime, it also makes sense for REIT risk managers to create terrorism risk management programs.

Nathan C. Gould, chief of technology and general manager for ABS Consulting, says companies can create terrorism risk software programs that are similar to those set up for other disasters.

AFTER TRIA, RETURN TO THE HUMDRUM

But, realistically, a REIT is more likely to encounter more mundane risks, such as construction defects or tenant defaults.

"A terrorist attack could be a very serious event, but when you're talking probability levels, lawsuits due to construction defects are much more likely to occur," points out Mary P. Hollins, principal with Hollins Risk Management Consulting in Seattle.

Safety features are critical. Hollins helps clients design buildings that are the most flexible and accomodating for tenants. Safety features, such as easy access to HVAC systems for ongoing maintenance, not only reduce costs for future retrofits but also decrease liability costs by limiting accidents and injuries that might result without these features.

Mold from seepage poses another significant type of construction defect. "This can be caused by poor design practices, such as the specification of materials that we don't know enough about yet," says Hollins. "Another cause can be poor construction practices, where materials are not installed properly during construction."

"Mold is currently a 'hot button' in our industry," says Simon's Horvath. "It has been getting a lot of attention lately." In some cases, it's possible to find mold coverage included in a property policy, but it's not common. "Usually, the only place to find coverage for this is in environmental policies, so the increase in mold exposure is placing some additional pressure on insurers that offer environmental policies," he continues.

The good news, though, is that the industry hasn't felt a lot of lender scrutiny over mold coverage. "I think the concern over mold has been sensationalized quite a bit, and over time, I think concern and attention to this problem will diminish," he adds.

"Overall, building owners need to stay abreast of maintenance issues and set up diligent preventive maintenance programs to reduce exposure from safety problems, mold growth, and so on," says Hollins.

The possibility of tenant default is always a concern, no matter what the property. But there are ways to deal with it that protect your interests."We work with clients on the risk of credit and tenant default," says Marsh's Schake. "We help them ensure the long-term viability of the revenue stream from their tenants. After all, at the end of the day, the value of the real estate is a function of the income and the rent."

One way to guard against tenant default is to purchase property carefully in the first place. "When a client expresses interest in buying property, we provide acquisition diligence for them, which includes a thorough review of tenant credit," says Jahn Brodwin, a partner with Schonbraun McCann Group in Roseland, N.J., a real estate consulting/accounting firm.

"When buying property that contains some potentially problematic tenants, sellers may be willing to enter into guarantees at closing," explains Brodwin. "The lender is then willing to lend based on the seller's guarantees."

There are other options, too, especially for office and industrial spaces, which often take a long time to re-lease. "Here, we often ask for irrevocable letters of credit, equal to six months rent plus a re-tenanting cost, from new tenants whose credit may not be strong enough," says Brodwin. "We are working on a couple of deals like this with clients right now."

These concerns underscore a different perspective and evolving role for today's REIT risk managers.

Gone are the days when REIT risk managers saw their sole responsibility as purchasing insurance. "We are finding that, overall, risk managers in the REIT industry are doing a much better job of looking at all of the risks their companies face," says Schake.

"They now look at risk from a holistic standpoint. In the past, many of them focused just on risk transfer--purchasing a tremendous amount of insurance. Now, they're doing a better job of actually managing risk."

Simon's Horvath agrees, noting that, risk managers have outgrown their roles as strictly insurance buyers.

"Our measure of success is not in buying the cheapest insurance, but in how we use our talents and expertise to transfer as much risk as we can away from the corporation," he says.

JOHN WILLIAMS, an Indiana-based freelance writer and author, is a frequent contributor to Risk & Insurance®.

April 1, 2005

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