With the Terrorism Risk Insurance Act of 2002 scheduled to expire at the end of the year and the Treasury due to give a report on the Act to Congress by June 30, there is renewed focus on the issue.
Fitch Ratings released a report last week stating that its policy regarding terrorism insurance remains largely unchanged except for fusion deals - which are becoming increasingly concentrated with large loans. "Recent fusion transactions are more likely to be affected by terrorism insurance issues due to this concentration, and therefore, will be reviewed closely for acceptable coverage," noted Fitch analysts, adding that rating actions will be taken if merited depending on the loan size within a pool as well as the coverage amount. The rating agency would also be taking a closer look at large loan deals, which have recently become more prevalent. Even if these deals have diversification working for them, concentration concerns still exist for these deals, Fitch said.
Because of the repercussions if the Act is not extended, the rating agency said that it is in favor of the passage of Terrorism Risk Insurance Extension Act of 2005, extending it for two more years. Fitch said this would allow the market time to develop a long-term solution to terrorism insurance.
Moody's Investors Service recently expressed concern over the lack of a viable private sector initiative that could replace the Act. "We are concerned that unless [the Act] is renewed, there would be a spike in premiums as well as reductions of coverage availability," said Moody's Managing Director Tad Philipp. In its first quarter CMBS report, Moody's said that anecdotal evidence suggests insurance policies written since the start of the year have adopted a conditional endorsement automatically voiding terrorism coverage if the Act is not renewed. The report also states that language in recent loan documents - in anticipation of the act's expiration - address the potential premium spike by either flatly requiring no terrorism exclusions or requiring borrowers to expend a stated percentage of the total property insurance premium for terrorism insurance with amounts ranging from 25% to 200% depending on how "trophy like" the asset is. There are also clauses requiring the purchase of terrorism insurance if it is available at commercially reasonable rates. "One of the biggest issues has to do with servicers," Philipp added. "They might have to deal with pricing and administration issues for a big part of their portfolio all at once in January instead of just dealing with regular monthly renewals."
The Treasury is scheduled to report to Congress by June 30 on the Act's effectiveness and on the private sector's capacity to offer this type of insurance without government assistance. Mary Stuart Freydberg, a director from Merrill Lynch, said that the Act has been successful thus far but the Treasury might want to see more private sector participation. "The Treasury would prefer not to extend [the Act], but given that it is inclined to be a believer in the private market system, it might be inclined also to listen to the market's assessment that an extension is needed and to require more market participation," said Freydberg. In an earlier report, Merrill noted that in 2002, a lack of terrorism insurance prompted meaningful downgrades for CMBS with a concentration on large or iconic buildings. Under the Act, however, borrowers and servicers were able to obtain terrorism coverage and ratings were restored.
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