Fitch: US Terror Insurance Lapse May Lower Coverage, Hurt CMBS

The failure of Congress to renew government-sponsored terrorism reinsurance could have repercussions for the insurance industry and segments of the broader economy, particularly commercial real estate, mortgage lending and construction markets in 2015. The Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) is slated to expire on Dec. 31, 2014.

TRIPRA is an important component of the CMBS market and has become common in many transactions. If it is not renewed, we identify approximately 20 Fitch-rated transactions that would be put on Rating Watch Negative. As loan documents require terrorism insurance over the life of the loan, CMBS servicers may increasingly force-place coverage from their own carriers. This would likely be at a very high cost if coverage can be found at all.

The impact on individual CMBS transactions would vary widely. If TRIPRA is not renewed it would have a negative impact on ratings of office properties with loans in CMBS single-asset transactions, for example. The lack of TRIPRA could also affect some multiborrower transactions, if the number and size of the loans lack sufficient coverage, or the risk of terrorism-related losses could not be mitigated by the rest of the pool. However, at this stage, no multiborrower transaction is included in the 20 deals at risk.

Before the terrorism reinsurance program was in place, insurers frequently excluded terrorism exposure from coverage. However, commercial property insurers have gradually enhanced their ability to measure and model exposure to terrorism events. Net exposures are managed currently through the availability of large reinsurance limits through TRIPRA.

Withdrawal of TRIPRA reinsurance protection without readily available substitute coverage will likely prompt insurers to exclude terrorism from property coverage so as to manage geographic risk aggregations in large metro areas. By statute, workers' compensation writers are forbidden from excluding terrorism coverage in their policies. Therefore, the expiration of TRIPRA may lead underwriters to withdraw from writing workers' compensation in large cities that are thought to be targets for terrorism.

Specialty or monoline workers' compensation or commercial property writers that focus on large urban markets have the greatest credit sensitivity to reductions in available terrorism reinsurance protection. Underwriters have typically made preparations to adapt to an insurance market without TRIPRA, but it will take time for some insurers to execute plans to reduce exposures and risk aggregations through revised coverage terms and policy cancellations, if there is not a swift renewal vote in early 2015.

Insurer withdrawal of underwriting capacity in response to a lack of terrorism reinsurance protection could have broader economic consequences, particularly in commercial real estate and construction markets. Compared to the conditions in 2002, it remains difficult to predict whether financial and property markets have a greater propensity to adapt to an environment without a government-sponsored terrorism insurance program.

The Senate adjourned on Dec.16 without voting on TRIPRA, which passed the House of Representatives on Dec.10. The bill would have extended the program for six years and set insurers' co-payments to 20% of losses, up from 15% in 2014, with reinsurance coverage attaching after an industry terrorism loss of $200 million compared with $100 million in the current program. While there is a chance for legislative action in early 2015, insurers must prepare for managing risk exposures without the terrorism coverage that has been in place in various forms since 2002.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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