Risk Management

No Terror Coverage, No Dice

Increasingly, banks are refusing to lend money to companies that don't have terrorism coverage. But procuring that coverage is getting damned costly.
David KatzMarch 13, 2002

While economists and pundits debate whether the economy is truly coming out of recession, one thing is certain: You’d be hard pressed to find a better time for investing in new capital projects. Inventories are finally down to where demand is starting to outstrip supply. Interest rates are lower than they’ve been for three decades. And on Saturday, President Bush signed a bill that will allow companies to write off a greater chunk of their investments in new plants and equipment.

In fact, in CFO’s most recent global confidence survey, 41 percent of the respondents said they plan on increasing capital spending in the next quarter. But finance chiefs looking to fund real estate acquisitions or finance the construction of new facilites may be in for a rude awakening. The awful truth is, many CFOs will find it difficult to line up adequate financing for sizable capital projects.

Indeed, in the sixth months after 9/11, lenders have started to insist that collateral of borrowers be fully covered for the risks of terrorism. “Today we will not consider any loans in excess of $50 million without full terrorism insurance coverage,” says Kieran Quinn, CEO of Column Financial, a Credit Suisse First Boston subsidiary. “And we are scrutinizing all loans in excess of $20 million if they have any terrorism exclusions.”

Quinn’s not exaggerating. In testimony before the House Financial Services subcommittee last month, the CSFB banker told lawmakers that he recently turned down six loans valued at about $300 million — and said he had discouraged many more.

Without coverage, banks are backing off. The problem is, many big corporations are finding it nearly impossible to procure “full” terrorism coverage at a sane price. In a recent report, Richard Hillman, financial markets and community investment director of the U.S. General Accounting Office, noted that one U.S company couldn’t get a mortgage on an office building that “had a guaranteed multimillion-dollar cash flow for the next 20 years.”

The reason? The company couldn’t buy enough terrorism insurance to cover the building’s replacement value, Hilliman said. Before the attacks, the company’s management paid $60,000 for $80 million of insurance, including terrorism coverage. After 9/11, only one carrier made an offer — and the price was $800,000 for far less coverage. “Without this loan and others like it,” Hillman asserts, “the firm’s future growth potential is severely limited.”

Better in the Luge

Granted, companies can buy freestanding terrorism policies with coverage limits of $25 million or $50 million. Lloyd’s of London and AIG, among others, offer such policies. But $25 million may not be a whole hell of lot coverage for a borrower with a fair number of billion-dollar properties.

As treasurers and risk managers are discovering, stand-alone terror coverage now costs as much as all other forms of property insurance combined. Until recently, a $100 million property policy (including terrorism coverage) might cost as little as $200,000, says Bob Smith, Northeast regional executive officer for insurance broker Willis. Today, the same policy costs anywhere from $400,000 to $600,000 — and excludes terrorism risks. To get an added $25 million of terrorism coverage, Smith says, a buyer might have to pony up an additional $500,000.

That’s putting terroism coverage out of reach for many companies. Even if insurers come down on their prices — and that’s not real likely — few mid-sized businesses will be able to afford terror coverage. “You could sell me the Hope Diamond at 50 percent off, and I still couldn’t afford it,” says David Mair, director of risk management for the United States Olympic Committee (USOC) and president of the Risk and Insurance Management Society.

Mair has first-hand knowledge in the difficulties of landing terrorism insurance. Just a day before the February 9 opening ceremony of the Olympic Games in Salt Lake City — and after 70 days of trying to negotiate insurance — Mair and his colleagues eked out a tad of the coverage the USOC needed to shield itself from the cost of lawsuits following a terrorist act.

The United States did much better in the luge. The small bit of insurance the USOC was able to buy cost it dearly. The committee ended up buying 5 percent of its expiring general liability limit and converting it to terrorism coverage — for the full price of the broader coverage.

A day later, the committee bought 45 percent of the general liability coverage it previously had — at 250 percent of the cost. And the U.S.O.C. has yet to secure property coverage for terrorism and other risks.

Fine Mess

Mair and other advocates for the federal terrorism insurance bills now before Congress argue that the lack of affordable coverage will slow the U.S. recovery by making lenders wary of new business.

The insurance mess doesn’t seem to be having much of an effect on current loans, however. That’s because lenders have less leverage to demand that current borrowers get insurance. While many banks are said to be serving notices of “technical default” on borrowers that lack coverage, the banks aren’t calling in the loans. And with good reason. Says the GAO’s Hillman: “If they pull out, they would be stuck holding that property without terrorism coverage.”

Indeed, lenders might find another obstacle in the courts. In one recent case, GMAC Commercial Mortgage Corporation was hit with a temporary restraining order barring it from forcing the owners of the Bloomington, Minnesota-based Mall of America from buying a terrorism insurance policy.

One of the owners, Simon Property Group, claims the mall’s loan agreements don’t require such coverage. Simon also said in a statement that the coverage GMAC proposed “has unreasonably low limits” and is nearly three times the cost of the mall’s all-risk property insurance for 2002. (GMAC did not respond to CFO.com’s request for a comment.)

Further, any lender tempted to sue to force a borrower to buy coverage might not be thrilled by the prospect of a lengthy legal wrangle. The lender “could be stuck with two to three years of litigation” about whether the lack of coverage justifies foreclosure, says Warren Bernstein, a real estate attorney at the Kaye, Scholer law firm in New York City.

Only lenders to companies who own properties considered to be prime terrorist targets have been willing to go to court. For less vulnerable buildings, Bernstein says, some lenders are thinking about accepting “that the terrorism risk can no longer be insured.”

Lenders reaching that conclusion might hike their interest rates to compensate for the risk. In turn, property owners could raise rents skyward to keep pace. And tenants would then become the terrorism insurers of last resort.