Insurance:  Insurance

Copyright (c) 2006 Ballard Spahr Andrews & Ingersoll, LLP. All Rights Reserved.

By Richard R. Goldberg, Esquire

I. Introduction.
"We will send that to the Insurance Department." "Let's let the brokers discuss the insurance." These comments comprise the typical discussion when it comes time to analyze the insurance provisions in commercial loan documents and other transactions. Yet the risk managers and brokers frequently do not have the requisite expertise to analyze the interrelationship of the various aspects of insurance and coverage with the loan which is the subject of the insurance and the related transaction documents.
It is the role of the attorney to reconcile those inconsistencies and to demand that the adequate and correct documentation be provided by the parties. Appropriate steps must be taken to reconcile the realities of the insurance agreements with the lease documents, loan documents, and other documents which affect them.
 
II. General Issues.
A. Insurable Interest. As a predicate to understanding the insurance provisions relating to a financing transaction, one must examine the transactions to make sure that the party requiring protection has an insurable interest in such property. By that it is meant that the party being protected by the insurance must either own the property, have a substantial economic interest in the property, or in some other way have contracted to derive benefit from the insurance.
While this seems to be a sine qua non, there are significant examples where the so called obvious insurable interest does not exist. For example, in the event of an ineffective assignment by a tenant under a lease as a result of a lack of consent by a landlord, the majority of courts hold that the insurance provided by the so called assignee of the ineffective assignment does not protect the landlord even though the landlord is named thereunder.
The point is that the party claiming the insurance interest has meet three criteria: there has to be an actual interest, a lawful interest, and a substantial economic interest. In the case of the previous example, there was a failure of the second criteria.
The issue often arises in a lease transaction where the tenant is insured under a blanket coverage provided by some superior title holder such as the owner of a mixed-use property or the fee holder of a leasehold. Under those circumstances, the landlord's lawyer must make the appropriate inquiry into the insurable interest.
B. Co-Insurance. Insurance carriers require that their insureds carry adequate insurance with respect to property coverage in order to make sure that the proceeds from the policies are capable of being used for restoration and the other purposes for which they are intended. Each policy will require that the stated amount of insurance equal a percentage of the actual value of the property insured. These percentages vary from 80% to 100%. The effect of violating the co-insurance provision is a reduction in the amount of coverage provided when a claim is made. For example, in a policy with an 80% co-insurance feature, if the policy provides for $ 7,000,000 worth of insurance, there is a loss of $ 5,000,000, and the actual value of the property insured is $ 10,000,000, the amount of the claim paid will be the claim times the percentage resulting from dividing the amount of insurance into the value of the property. In this case, this would result in a 70% payment of $ 3,500,000.
Therefore, it is imperative to ascertain the co-insurance feature of an insurance policy and to point it out to the client. A policy that inadequately insures is almost as useless as no insurance at all.
One method of avoiding co-insurance is to have an agreed value endorsement. Under this endorsement the insurance company contracts to pay the amount specified in the endorsement without regard to valuation issues and methodology.
C. Certificates of Insurance. There is an illusion regarding an examination of insurance when certificates are provided by tenants to landlords. The illusion exists that the certificate in fact, is binding on the insurance company. In the first place, insurance certificates are usually issued by agents of the insurance company whose authority is at best uncertain. Secondly, until the early 1990s, certificates of insurance contained the following statement: "This certificate is issued as a matter of information only and confers no rights upon the certificate holder. This certificate does not amend, extend or alter the coverage afforded by the policies below." Thus, it is obvious that certificates might not adequately represent the insurance being provided. Indeed, the only claim available, if the certificate misstates the insurance, is against the errors and omissions policy of the issuer of the certificate which is inadequate protection because of lack of coverage and the inordinate length of time necessary to recover in a tort action.
In the early 1990s, an association called ACORD, which is a collective nonprofit organization subscribed to by most of the insurance carriers in the United States, issued certificates in form both non-binding and binding. The non-binding forms of insurance are ACORD 25 Form as evidence of liability insurance and ACORD 24 Form as evidence of property insurance. These certificates contain the disclaimer quoted above.
However, ACORD has issued certificates known as the ACORD 27 and ACORD 28. The ACORD 27 and ACORD 28 are styled as "Evidence of Insurance." They contain the following statement: "This is evidence that the insurance as identified below has been issued, is in force, and conveys all the rights and privileges afforded under the policy." The certificates provide for notice to additional interest parties of termination and notification of changes. The ACORD 27 and 28 do not contain a statement denying amendment, extension or alteration of coverage, does contain a unequivocal obligation to give notice and purports to convey all the privileges of the policy to the certificate holder. An ACORD 27 and ACORD 28 are available only for property insurance.
The benefits of the ACORD 28 certificate arise because it has added many of the items as "boilerplate" which have been requested in connection with the issuance of the ACORD 27. The form is new and many insurance agents and risk managers remain unfamiliar with the certificate.
An attorney representing a landlord in a lease transaction or a lender in a loan transaction should insist on an ACORD 28 certificate if copies of the policy are not available.
Nevertheless, it is best to obtain copies of the policy of insurance as the primary evidence of the terms and conditions of the policy. This may not be possible where coverage is provided by a blanket policy or where the interrelationships of other insurance not the subject of the lease are confidential or too complex for appropriate analysis. Under those circumstances, the ACORD 28 certificate is the only acceptable evidence of insurance. (N.B.: As of Fall 2006, the ACORD 27 and ACORD 28 certificates have been radically changed. They no longer contain the language that binds the insurance company. As a result, certain lenders such as Freddie Mac have decided that non of the available Certificates will be used in closing their transactions. The recourse available as of now is to receive a binder executed by the insurance company, receive certificates executed directly by the insurer or receive a copy of the policy. These are the only effective methods of determining that the insurance carrier has agreed to the insurance provided for the particular transaction.)
D. Named Insured vs. Additional Insured:  Mortgagee Loss Payable. In every lease transaction, a request is made by the landlord to be named on the insurance policy in some fashion. The manner of such designation is frequently confusing. There are several alternatives: one may be a named insured under a policy, an additional insured under the policy, or a designated mortgagee for the payment of losses under a mortgagee loss payable endorsement. The important question that one asks is which is the best way to proceed?
There are palpable differences between the designations. The named insured under a policy has the full status of the insured including coverage of its officers, its employees, its partners, its agents and all affiliates and entities that comprise it. However, it carries along with it the detriment of being subject to all the defenses that the insurance policy may assert against the insured. While the status of additional insured does not confer as broad a coverage, it does not come with all the baggage of defenses and, therefore, most of the defenses, including fraud, cannot be asserted against the additional insured.
In the insurance context, the preferred status for a landlord is to be an additional insured. Because of the absence of defenses, and because the named insured status requires the payment of an additional premium (often 50% or more of the original premium on the policy), the additional insured status is appropriate and sufficient.
E. Insurance Company Ratings. There are three (3) recognized methods of evaluating insurance companies based on independent ratings. The following will give a brief analysis of the rating systems and their differences.
Best Insurance Ratings. The principal rater of the insurance industry has been the A.M. Best Company. The A.M. Best Company has provided insurance ratings for property insurance companies, life companies and related products. Best provides two ratings: a Letter rating and a Roman Numeral classification. The Letter rating includes many qualitative and quantitative factors of an insurance company's financial condition and operating performance. It considers liquidity, profitability, capitalization, spread of risk, reinsurance, diversification, loss reserves, surplus adequacy, management experience and market presence. The Best ratings range from AA+ to F. The secured ratings at Best are considered AA+ to B+. Anything from B to F is considered vulnerable. E and F are in state supervision or in liquidation.
In addition, Best will provide a roman numeral classification based on policy holder surplus. These range from Roman Numeral I to Roman Numeral XV which is smallest to largest.
The Standard & Poor Property/Casualty Insurer Solvency Review. Standard & Poor analyzes available financial data provided by the National Association of Insurance Commissioners to determine a qualified solvency rating. S&P analyzes the claims-paying ability and potential solvency of a number of insureds throughout the county. In order to have claims-paying ability analyzed, an insurance company must voluntarily submit to S&P scrutiny. However, in order to broaden that base, since only a small portion of insureds submitted to the voluntary review and analyses, S&P has developed a broader form called Qualified Solvency Ratings.
The claims-paying ability of S&P ratings range from AAA through EEE to R. AAA being the best, EEE being extremely vulnerable financial ratings and R being regulatory action.
The border form of qualified solvency ratings are as follows: BBBq - statistical tests indicate adequate or better financial security; Bbq - statistical tests indicate that financial security may be adequate; Bq - statistical tests indicate vulnerable financial security; R - regulatory action.
The S&P ratings as property and casualty insurers are not as clear as the Best ratings.
Standard & Poors, Moody and other rating agencies review of the debt of insurance companies. As is typical of all companies which issue public debt, the rating agencies will give standardized ratings to the debt instruments of public insurance companies. In the case of Standard & Poors, these range from AAA downward; and in the case of Moody's from AA downward. Investment Grade ratings in the case of both major rating agencies entail ratings that range from either AAA to BBB- in the case of Standard & Poors, or AA to BBB- in the case of Moodys. An analysis of the debt instruments issued by insurance companies can often be helpful in assessing their financial quality.
F. Notice of Termination, Modification, and Cancellation. It goes without saying that lenders provide in the loan documentation that cancellation, modification, surrender or termination of the policy will constitute a default. In the case of modification, cancellation or surrender, breach of this provision will give rise to a successful action against the insurance company which fails to provide such notice. However, the landlord need beware in the event of termination by the insurance company for nonpayment or other action other than cancellation by the act of the insured.
A number of cases have held that an insurance company has no obligation to give notice of its termination for nonpayment or other cause to a landlord in the same fashion that they do as a result of the over act by their insured. This requires the attorney to inform the landlord of this risk and to recommend that the appropriate diligence be followed in dealing with the due date of insurance. There is an endorsement available which provides that the insurer shall give notice to third parties in the event of cancellation for non-payment.
G. Mortgagee Loss Payable Clauses. In the typical loan document, borrowers are required to obtain mortgagee loss payable status for their lenders. There are two typical forms of mortgagee loss payable clauses without significant difference. One is the "New York Form" and the other is the standard form. The mortgagee loss payable clause provides that the insurance company will, under all circumstances, make all payments pursuant to the insurance policy to the lender regardless of the directions or instructions of the insured, additional insureds and the provisions of the policy.
The relationship between the mortgagee and insurance company is a contractual relationship. A mortgagee loss payable need not have an insurable interest in order to receive insurance proceeds where they are so designated in the policy. Therefore, it is incumbent upon lenders on refinanced transactions and borrowers to take steps immediately to change the mortgagee loss payable clause from the old lender to the new. The insurance company, in the case of a mortgagee loss payable clause, will follow its most recent instructions. While there should be no issue of the disgorgement of mortgagee loss payable proceeds by an insurance company not otherwise entitled to those proceeds, one can understand that there is a casualty before re-designation, it may take some time for the proceeds to find their way into the proper hands. Not only may there be a delay in the application of the proceeds, but there is also a loss of investment potential. Frequently, the well-informed lender will require evidence that the mortgagee loss payable clause has been changed with respect to a new loan at the closing table or shortly thereafter.
H. Other Forms of Insurance Not Necessarily Found in Real Estate Transactions. In the case of a manufacturing business, it is important to reconcile the insurance requirements in a loan that is not secured by real estate with the standards in the industry for insuring equipment, manufacturing processes, software, computer operations, and other essential items that are required for the operation of a business. This insurance is in addition to boiler and machinery insurance and is frequently a specialty item. When representing the lender, one should make due inquiry of the nature of the insurance and have the lender's risk managers advise as to what form of policies are appropriate for this industry in which the loan is being made.
An important thing to remember about insurance is that in the right market, almost any kind of insurance can be written or tailored. If you are engaged in a transaction where real estate is not the foundation, it is important to sit with the lender and the lender's risk manager in order to determine whether or not there are any risks inherent in the business that are not typically covered by insurance. It is entirely possible for insurance carriers to write special lines and special forms of policies that will cover a-typical businesses and make sure that there are proceeds of insurance available to repair or replace significant items of machinery and equipment as well as inventory that may not be readily replaceable. Of course, this insurance goes hand and glove with the business interruption insurance discussed later in this article.
 
III. Forms of Insurance Coverage.
A. Property and Casualty Insurance. The standard form of property insurance available today is known as Building and Personal Property Coverage Form. This coverage replaced fire and extended coverage which only insured property against perils named in the policy. There are three forms of loss coverage: Basic Form, Broad Form, and Special Form. Special Form provides the broadest applicable coverage and it is the most desirable. Special Form covers everything unless excluded while the Basic Form covers only included perils and the Broad Form has a long list of exclusions.
There are three separate values for which property may be insured: property may be insured for its actual cash value which means replacement cost minus depreciation, replacement cost or stated value. Replacement cost means the full cost of replacing the property to its condition prior to the casualty. Clearly, it is important to obtain insurance that will also permit reconstruction of improvements to fit new and modern building codes and construction techniques. Therefore, the insured should have a betterment and increased cost endorsement and Law and Ordinance coverage which will allow for the construction to fit new codes and to take improvements in building technique and architecture into consideration. Without such endorsements, replacement value may not be adequate to permit the building or the property to be restored to a usable condition since it may not be able to be built by law in the manner in which is existed prior to the casualty. Stated value means that the property is insured for the value stated in the policies without regard to depreciation or replacement cost.
The policy will contain a limit and despite the fact that replacement cost is specified, the limit of the policy will dictate the maximum amount to be paid by the insurer.
There are a number of additional coverages available to insure property. Earthquake insurance is not provided for under the all-risk policy. In heavy earthquake areas, it is frequently possible to obtain earthquake insurance for only a portion of property with heavy deductibles. Landlords will frequently waive the requirement for earthquake insurance in areas of low seismic peril as indicated by national seismic studies.
Flood insurance is an excluded peril and is available under the National Flood Insurance Program, which is issued to improvements located within a flood plain pursuant to governmental regulations. In order to obtain flood insurance, you must have a certified survey that shows that the improvements are located within a designated flood plain of the United States.
Often, where insurance markets are tight, specialty coverages are purchased as an adjunct to the main policy. This form of coverage is known as "Difference in Conditions" or "DIC". For example, when the Southeast experiences a high incidence of hurricanes, the wind damage of the policy will be separated from the remainder of the casualty insurance and marketed with lower limits and higher premiums. It is also possible to obtain additional flood insurance beyond the national program through this vehicle. In Florida, the DIC policy for wind damage is presently provided by one or two commercial carriers and through a State funded program. The coverages are frequently marginal in coverage amount when there has been a high frequency of the type of casualty for which the DIC is purchased.
Casualty insurance does not cover the failure of boilers, heating, ventilating and air-conditioning equipment and other machinery (in some instances elaborate computer functions required to operate the business). This is covered by boiler and machinery insurance. This insurance covers the explosive or sudden failure of systems rather than losses resulting from gradual deterioration. The principal feature of boiler and machinery insurance is to provide an annual inspection by the insurance company as part of the premium which is a valuable preventive maintenance tool for Owners and landlords. The coverage also insures that there will be resources available to advise and pay for appropriate replacements resulting from damaged or destroyed machinery and other operating equipment.
Another important property coverage is specialized computer equipment and valuable paper coverage. Computers, data and office records in general are frequently excluded from all-risk policies and tenants should be encouraged to insure these records since they form an important part of their business.
Property owned by others are frequently covered under a sub-limit or smaller limit. Therefore, an analysis of leases of insured property which determines who owns tenant improvements is of significance. If the tenant owns tenant improvements, an insurance examination of the form lease and a requirement that tenants insure their tenant improvements for full value is necessary.
During the construction period of building, all-risk insurance does not cover the property. The Owner of a building should carry Builders Risk Insurance with completed operations coverage. This covers the improvements during construction. An important distinction of Builder's Risk Insurance is that it does not insure for defective work, it only insures for damage due to casualty.
Finally, there are a number of special environmental coverage that are beginning to be available. For example, a number of companies, including one of the major title companies, has made available insurance that will only insure that a Phase I and a Phase II have been adequately performed and any deviation as a result of the negligence of the inspector will be covered by this insurance. These coverage are extremely expensive, and while they may provide protection, it is important to examine their utility on a cost-benefit basis.
B. Business Interruption Insurance; Rental Interruption Insurance. It has become mandatory for lenders to require landlords to carry rental interruption insurance and for landlords to require tenants to pay for the cost of the policies. It is also a common practice for landlords to attempt to get their tenant to carry Business Interruption insurance. The concepts are simple. If the policy conditions are met, the insurance company for the period insured will pay loss of rents in the case of rental insurance or loss of profits in the case of business interruption. However, as simple as this sounds, there are a number of requirements for the lenders, landlords and tenants to examine.
For insurance to be applicable, a number of elements must be present. There must be physical damage to property, which is identified in the policy, the peril that caused the rental interruption must be covered, the peril must be the cause of the loss, there must be an actual interruption of operations, and an actual loss of rent or business income must exist.
The last requirement frequently result in a trap in the event of rental interruption. If the lease under which the rent is being paid does not provide for a rental abatement in the event of a casualty, the rental interruption insurer will not make payments. This is an important point since many landlords would like to voluntarily abate under certain circumstances such as utility interruptions, yet, wish to preserve their options not to be required to do so. If they do not agree to such an abatement in the lease, they cannot collect their rental insurance. Landlords should include in leases rent abatement rather than strict adherence to typical landlord practice which offers rent abatements under limited circumstances.
The length of coverage is frequently an area of contention between tenants and landlords. Lenders and landlords will often insist on eighteen (18) months to two (2) years of coverage which is resisted by tenants because of the expense. This is a business decision. However, it is abundantly clear that major casualties are frequently not resolved within the typical one (1) year period of most rental interruption insurance terms.
An important feature of rent and business interruption insurance is that there need not exist a loss of rent or income if there are increased expenses as a result of the covered peril. Those expenses are also payable.
Another way for landlords to assure themselves of adequate coverage is to insist that their tenants provide that their tenant has business interruption insurance so that even if their rental insurance is not provided for some reason, business interruption insurance will provide an adequate source of funds so that the payment of rent will proceed unabated throughout the term of the lease.
 
IV. Commercial General Liability.
Commercial general liability insurance covers the tenant against third party claims. The landlord under this policy is an additional insured since the mortgagee loss payable provision, is, of course, inappropriate. Commercial General Liability is the present form of policy and has replaced the Comprehensive General Liability Coverage. It is more expansive and includes the following coverage: (i) it includes bodily injury caused by the insured, (ii) it insures property damage to third party property (it does not insure the property of the insured), (iii) it insures against personal injury which is defined to include slander, liable, invasion of privacy, emotional distress and false imprisonment, (iv) it provides medical payment insurance without assessment of faults, (v) it provides for defense costs, (vi) it covers liability assumed by contract such as indemnities. The last feature is an important difference between "commercial general liability form" and "comprehensive general liability form" which required a specific contractual liability endorsement. In some jurisdictions, punitive damages are either covered expressly or not expressly excluded. About half the jurisdictions do not permit punitive damage coverage because this would violate public policy.
In addition, if the tenant has a restaurant operation in its premises, the landlord should require that the tenant obtain or cause its tenant to obtain appropriate liquor liability insurance. There is an increasing number of decisions holding landlords responsible in the event that there is an injury due to the excessive use of liquor.
These policies should be written for primary coverage. That means that the coverage comes first no matter what other coverage is available. Often, if there are more than one coverage, the insurance carriers will dispute which coverage is appropriate. If the coverage is primary, however, you may rely on your carrier to protect you as landlord and your tenant without regard to recourse to other policies.
The policy should specify the specific amount of the insurance. Frequently, the policy will specify an amount per occurrence and an aggregate amount of coverage. Pursuant to the aggregate amount of coverage clause, the amount of insurance during the policy period is limited to a maximum amount. In the event of a blanket policy which covers multiple locations, a per location endorsement should also be obtained so that the aggregate only applies to the location being insured. If you are a landlord, and the lease covers specific locations, failure to do this can seriously impair your coverage.
Commercial General Liability is frequently written in layers by different carriers. In order to obtain sufficient coverage, insureds will often buy excess coverage. For example, the first $ 3,000,000 will be provided for by Insurance Company A, the next $ 5,000,000 will be provided by Insurance Company B, the next $ 10,000,000 by Insurance Company C and so on. Umbrella policies require one important feature, they are all following form policies. In reviewing the various layers of insurance, it is important to make sure that each preceding layer has adequate provisions that satisfy the following form features of the succeeding layers. In other words, each policy must fit together completely or coverage will be denied.
Another important aspect of examining commercial general liability policies is to determine whether they are written on a occurrence basis or a claims-made basis. An occurrence policy applies to an injury or claim made during the time the policy is in effect regardless when the claim is made. A claims-made policy is limited to insuring those injuries or damages which are claimed when the policy is in effect. Under certain conditions, occurrence policies, which are much broader in coverage and will expose the carrier to a much greater period of time of coverage, are difficult to get. A claims-made policy will frequently give rise to the need for an additional insurance policy which provides for retroactive application. This is known as a "tail".
The final issue is analyzing the commercial general liability policy is to determine whether or not the tenant, in its lease agreements, has provided for an adequate waiver of subrogation or waiver of right of recovery, as well as an indemnity from their tenants against claims made by third parties arising out of the operations of their tenants. Waivers of subrogation are simple creatures of contract law which insurance companies will honor. They permit their policy holders to agree to waive their common law right of subrogation -- that is to sit in the shoes of their insured in order to assert claims for negligence against certain parties. In this case, the waiver operates to prevent the insurance company from suing tenants and bring pressure to bear against the most valuable producer of income which supports the lease underwriting.
A waiver of right of recovery is preferable since it waives the claim thus eliminating the right to subrogation.
The importance of an indemnity, which goes hand-in-glove with a right of recovery and waiver of subrogation, is that your tenant should be protected against claims by third parties arising out of the use of premises by a tenant. This is not in conflict with a waiver of a right of recovery since that is a contractual provision directly between two parties and indemnity provision protects the parties against third party claims.
 
V. Self Insurance.
Frequently, tenants of significant net worth will ask for the right to self-insure the risks required to be insured under the leases and under lease agreements. Landlord's counsel should view this request with a careful eye. It should be noted that most insurance companies themselves do not engage in programs of self-insurance. In fact, not only do these parties refuse to self-insure, they in turn reinsure their risk among themselves so as to minimize losses. Self-insurers do not have the privilege of reinsurance.
A separate analysis is required for self-insurance of property and casualty insurance as opposed to liability insurance. Under property and casualty insurance, the net worth of the intended self-insured is a far better test in order to determine whether or not permission will be granted. The purpose of insurance is to spread the risk of random occurrences among third parties who are paid for providing the insurance coverage. The occurrence of a casualty to property in a specific location is more likely to be random and not wide spread. Therefore, the risk is more capable of being underwritten.
A review of the net worth of the party compared to the amount of the risk of being insured will provide some level of comfort. A multiple of net worth of at least 15 - 20 times the amount of property insured is a reasonable test. Should the landlord desire that the facility be rebuilt, or, more importantly, should lender require that the proceeds be used to pay down the debt, there needs to be adequate net worth to underwrite the obligation without forcing a significant liability which will give impetus to the self-insured to fail to meet its obligation.
Of course, an analysis of the location of the insured property owned by the self-insured versus the location of other similar facilities should be undertaken. If there is a concentration of facilities in a locality that can be subject to perils such as earthquake, hurricane, tornado, flood, or other similar casualties, then the appetite for self-insurance is decreased.
The analysis for permission to self-insure commercial general liability should be much more restrictive. Net worth plays a small part in this analysis. The possibility of multiple random events which would tax the net worth of even some of the Country's largest corporations is indeed possible.
The permission to self-insure should be accompanied by an adequate program internal to the self-insurer which uses funded reserves based on principles similar to that which insurance companies use. Naturally, tenants and their tenants will resist the necessity of reserving fund since under these circumstances, it is tantamount to purchasing insurance and, under certain circumstances, may provide for greater liability.
In any event, financing the risk of insurance, whether paying losses out of cash flow, using unfunded reserves, using funded reserves or borrowing, requires an adequate analysis and understanding by the parties to the agreement and the tenant's tenant.
Another form of self-insurance is the deductible or retained risk. Under an insurance contract with a deductible, the insurance carrier does not pay for the first amount of a loss up to a specific dollar limit. The amounts of deductible should be carefully examined by the parties.
An alternate form of insurance which provides the tenant with use of cash flow available for insurance premiums to pay losses and allows the landlord to be comforted by the existence of an insurance contract is the paid loss retrospective risk policy. Under paid loss retrospective risk, the insured actually pays claims and losses to settle the legal fees and administrative expenses to the carrier which in turn administers these payments. As far as third parties are concerned, an insurance contract exists for satisfying contractual requirements. Yet, despite the existence of the contract, until the maximum amount of the insurance contract is reached, the insured is allowed to fund losses out of the cash flow when actually paid thereby retaining the use of its money.
The role of the insurance carrier upon which third parties can rely comes into play by providing an insurance contract, claims services and by insuring all losses above the stated amount of the policy. The carrier charges a fee for these services. The insurance aspect of the paid loss retro is the carrier's agreement to pay all losses above the amount contracted to be paid by the insured. Only the largest property owners can afford paid loss retrospective insurance with a cash flow feature.
 
VI. Restoration and Casualty.
Insurance coverage provisions have to dovetail closely with the restoration obligation under leases, underlying leases and underlying side agreements such as reciprocal easement agreements. Frequently, an analysis of project documents of complex mixed use projects and shopping centers will reflect that there is no coherence to the negotiation to casualty provisions. The landlords counsel must insist that there be coherence to these provisions so that the landlord can make sure that its security is adequately protected by insurance.
It has become a rubric of lending that leases contain a provision which require tenants to pay to landlords insurance proceeds to pay off the debt and not be used for restoration. This portion of the document is always contested and becomes the subject of much discussion.
It should be noted that, in some states, there are statutes requiring landlords to make insurance proceeds available to their tenants for the purpose of restoration. In other states, while statutes do not impose such requirements, courts have imposed the covenant of good faith and fair dealing upon the entire transaction which should give landlords great pause if, they in an untrammeled fashion, require the application of insurance proceeds toward repayment of debt.
In any event, in leases where there are major credit tenants which comprise significant collateral for the underlying lease obligation, the landlord will frequently agree to follow the coverage negotiated in the lease documents in determining whether or not to permit casualty proceeds to be used for restoration of the premises.
Lenders' views vary depending on the nature of the loan. A "relationship" lender is more likely to permit rebuilding in the loan documents than the "securitized" lender. In the case of a securitized loan, a borrower should try to negotiate, as a minimum, for the restoration decision to be made by the loan servicer.
Notwithstanding an agreement to make proceeds available, the prudent lender and landlord will require that insurance proceeds be paid to it or to a financial institution to be administered in the same fashion as a construction lease. It is important that there be sufficient funds to complete the restoration; that if the amount of funds are not in balance, before further work is permitted, the tenant be required to come up with "equity" to finish the restoration; and that there be sufficient hold backs, lien waivers and other construction lease type features. This is frequently done through the imposition of an insurance trust where the landlord holds the proceeds or a fiduciary, such as a commercial bank will hold the proceeds under a trust agreement.
It is not uncommon for landlords, notwithstanding the fact that restoration would otherwise be permitted, to require that proceeds be paid over to it as debt repayment if the casualty occurs during the last several years of the lease.
With respect to major credit tenants, landlords and lenders will frequently require that there be a sufficient term left on the lease to make restoration worthwhile. Therefore, as counsel, one should analyze the documents under which restoration funds are made available on behalf of tenants and should recommend that the lease be amended to provide for extensions of the term if the remaining term is insufficient in the business context to justify the release of casualty proceeds.
 
VII. Insurance Since 9/11
The tragic events of September 11, 2001, have had a profound effect on the placement of insurance in connection with real estate transactions. The major insurance companies have drastically revised their coverages, the rating agencies have downgraded many insurance carriers, and lenders and landlords alike have revised their insurance requirements in an attempt to cope with the ever-shifting coverage of this situation.
A. Terrorism Insurance. Almost immediately, the major insurance companies and ISO added losses in acts of terrorism to the risks that were not insured under the existing form of property and casualty insurance.
Major lenders in the country immediately reviewed their portfolios to see whether or not terrorism was covered under the normal casualty policy. Since it was not an exclusion (other than the typical nuclear, chemical, biological or war exclusions), for the moment, the lenders were in reasonable shape with respect to existing loans in their portfolios. However, as insurance coverage, which is typically written on an annual basis, rolled over or new loans were being made, the lenders began to insist on terrorism coverage.
The traditional insurance carrier would not provide the coverage. Five carriers filled the gap and were prepared to write terrorism insurance coverage with limits of either $ 200,000,000 (and in one case up to one billion dollars) for premiums that far outweigh the cost of the regular casualty insurance. Lenders began to require terrorism insurance for either their entire portfolio or certainly for those properties they consider to be trophies upon which they have made a loan. When the borrower community resisted, several actions were brought by lenders pursuant to the existing loan documentation which typically provided that the lenders could provide insurance in the event the borrower failed to meet the lender's requirements as they existed from time to time with respect to insurance coverage. Several lawsuits were brought concerning major real estate loans in the United States. A lawsuit was brought with respect to the Mall of American in Bloomington, Illinois, by GMAC-CM against its owners, The Simon Property Group, and TIAA-CREF, requiring the purchase by the borrower of terrorism insurance for the property. This lawsuit was later settled.
Another lawsuit was brought by a number of carriers concerning large prominent office buildings in New York and Boston whereby the lender placed the terrorism insurance utilizing the loan documents against the wishes of the borrower. At this writing, the court hearing the case refused to grant an injunction to prevent the forced placement.
The definition of "acts of terrorism" is worth examining. For example, ISO defined terrorism as "an action or use of threat or force or violence or commission or threat of a dangerous act or threat of an act which interferes with electronic or mechanical communications which is used to intimidate the government or civilian population and has the intent to further a political, ideological, religious, social, or economic objective or to express opposition thereto. The ISO further proposed threshold of coverage which would disappear if the property casualties sovereign the entire United States and Canada, including all its possession, exceeded $ 25,000,000 or fifty or more persons died and/or came from nuclear, biological or chemical attacks (which were already excluded under other portions of the casualty policy). Each lender that provided coverage also had a slightly different definition of terrorism so that if layered coverage was required, it was possible that the various layers would have different definitions of acts of terrorism.
Finally, the lending industry attempted to rationalize the conclusions about the necessity for terrorism insurance. The industry generally split into two factions. The securitized lender continued to require terrorism insurance on new loans and sent out letters on existing loans requiring it for virtually all kinds of projects. The insurance company and relationship lenders, such as commercial banks, took a different approach and granted terrorism insurance waivers. These waivers took various different forms. For example, some lenders would waive it until it was commercially reasonably available if a majority of similar situated owners in the same general location obtained coverage. Other lenders required terrorism insurance as was maintained by prudent owners of similar type of properties. The most liberal lenders required commercially reasonable efforts to obtain terrorism insurance at commercially reasonable rates.
Moody's presently is the only rating agency to attempt to develop a standard for terrorism insurance for their pooled securitized coverage. Moody's analyze property using a table considering the nature of the asset being insured and the nature of the pool in which the asset was placed. Asset Tier 1 generally consists of trophy or upper tier assets which included the tallest buildings in central business districts, tourists attractions or major attractors of shoppers or other consumers. Asset Tier 2 consists of large central business district buildings, super-regional malls which did not fit into Tier 1, and large multi-family apartment buildings. Asset Tier 3 are other properties.
The Pooling Tiers worked as follows: (i) Tier 1 consisted of single asset deals; (ii) Tier 2 consisted of large loan transactions, and (iii) consisted of conduits. Moody's then would require or would re-rate the portfolios depending on where the particularly property was located within the various Asset Tiers. For example, if a property were in Asset Tier 1 and Pooling Tier 1, lack of terrorism insurance would result in a downgrade. On the other hand, if a property were in Asset Tier 3 and Pooling Tier 3, no terrorism insurance would be required. Moody's has downgraded several portfolios.
Finally, in response, Congress has passed and President Bush has signed, the Terrorism Risk Insurance Act of 2002 ("TRIA"). This is an attempt by Congress to regulate terrorism insurance and supply secondary support to the insurance company markets. The important points are as follows: (i) the Act is in effect until December 31, 2005; (ii) primary insurers in the United States must provide terrorism insurance which does not differ materially from the terms and amounts of other coverages applicable t the remainder of the casualty policy and terrorism insurance must be offered in conjunction with that policy; (iii) an act of terrorism is defined as domestic terrorism only which results in a violent act that is dangerous to life or property, resulting in damages of at least $ 5,000,000 in the United States and that is committed by an individual or individuals acting on behalf of any foreign person or foreign interest as part of an effort to coerce the population of the United States or to influence the policy or the conduct of the United States by coercion. Acts committed as part of war are excluded. As you can see, domestic terrorism is excluded. Terrorism insurance does not override the existing nuclear, biological or chemical exclusions. If you have an existing terrorism policy, it may be wise to cancel your insurance and seek a renegotiation since, although rates are not mandated by the Act, it is entirely likely that the new form of terrorism insurance will be less expensive. However, there is no direct pricing relief for terrorism only coverage purchased prior to the Act and the premiums for that are deemed to be fully earned. The federal government simply provides re-insurance to insurers. There is a deductible of one percent (1%) of the premiums earned by that insurer from lines of insurance. In future years, the deductible rises to seven percent (7%) in 2003 and ten percent (10%) in 2004, and fifteen percent (15%) for claims accruing in 2005. There are penalties for non-compliance. The most important provision provides for policy holder surcharges if federal payments are made and the non-reimbursed insured payments do not exceed a threshold, the federal government may impose a surcharge on policy holders to recoup the federal payments up to a threshold specified at the act. The program terminates on December 31, 2005. The Act requires litigation in a federal court but does not displace contractual arbitration nor limit punitive damages.
Since the passage of the Act, terrorism insurance has become much more readily available for the typical transaction at rates that approach the reasonable. Part of this stems from the recognition by the industry that acts of terrorism are not likely to occur with respect to the vast majority of properties insured. The remainder arises because the cost of standard insurance coverage has become increasingly expensive because of cost recovery by the companies from the 9/11 events, and poor portfolio performance. Several categories remain special risks. These include "trophy" properties such as high rise office buildings in major cities, major hotels and resorts and enclosed regional malls. Also, properties in New York and Washington, DC are treated specially. They has been an agreement among major insurance carriers to insure New York and DC properties in a special pool.
Congress has passed new legislation extending TRIA. The extension is for two years, raises the amount of private contribution in the event of a loss, and requires the government and private industry to reach a private market solution for terrorism insurance in the future. The legislation also more closely regulates the area of captives and will declare captives "abusive" unless there is significant funding by the owner of the captive.
B. Retentions, Deductibles, Captives and other Money Saving Devices. 
Insurance companies, to ameliorate risk, and insureds, to limit costs, have become more inclined to institute practices which place more burden for initial losses on the insureds. Traditionally, deductible amounts from payments for insured events has been the classic response of the industry and insureds. The market for deductibles has varied from reasonably low amounts ($ 10,000) to high amounts ($ 100,000). Deductibles for Commercial General Liability have traditionally been much lower than Casualty Insurance deductibles Of course the deductible does not specifically comply with most well-drafted insurances clauses. The clause must be tailored to meet the deductible situation.
However, these measures have not provided insurance companies with sufficient risk relief, particularly in the area of Liability Insurance and Casualty Insurance in areas where hurricanes are prevalent. The carriers have progressed to a program where the insured retains a portion of the risk, usually on the front end of the loss repayment. When this occurs, the carrier is relieved of responsibility to third parties for the first portion of the loss. The basic difference between the deductible and the retention is that the underwriting permits the carrier to disregard all claims below the retention limit and their associated defense and other costs. If a deductible exists, the carrier must still administer the claim even though a portion of the financial responsibility belongs to the insured.
In order to comply with the typical insurance clause, the insured is required to disclose to its landlord or lender the nature of the retention and its amount. In effect, the underwriting of the retained amount is shifted to the landlord or lender. Third parties which are insured primarily by other entities insurance (additional insured status or mortgagee loss payable) must review retentions with care because the financial strength of the tenant or borrower is relevant to the retained amount as well as the fact that defense and administration of the risk may not be available for small claims within the retained amount.
If the cost of insurance proves to be to high or the retentions or deductibles are in amounts that exceed the norm and the ability of the insured to pay, affinity groups will often form "captive" insurance companies. These companies are frequently organized "off shore" and are composed of the insureds with like businesses or risks. Hospitals and medical groups have become frequent users of captives. Similarly, developers which operate significant portfolios will often form captives to insure the deductible or the retention in connection with their insurance program,
A few words of caution for the additional insureds and mortgagees. The captive will not have a Best rating nor will they be likely to be rated by S& P or any other rating agency. Thus, an examination of their financials, reserves, and how premiums are established becomes a high priority review. These examinations are not easily done nor is the information necessarily easily comprehensible at first review. The typical insurance broker may not be of much help. If the issue of insurance is sufficiently important, the landlord or lender should retain one of the sophisticated risk management firms to assist with the analysis.
This area of risk and premium amelioration is rapidly evolving and it is difficult to predict the direction in which insurance companies will proceed to stay ahead of the effect of significant recent claims and the loss of investment income to low interest rates.
C. Other Insurance Issues. Best, the most commonly accepted rater of insurance companies, has significantly reduced the rating of many of the insurance companies because of the losses suffered pursuant to the acts of September 11, 2001, and the numerous hurricanes of the past several years. The implication for financing transactions are that commonly accepted ratings of insurance companies imposed on transactions by lenders may not be capable of being satisfied by borrowers. For example, while casualty insurance ratings strangely enough have remained constant, liability insurance ratings have plummeted and many recent transactions have had borrowers scrambling to try and put together layers of insurance to meet these requirements.
Lenders are also no longer willing to close major transactions based on binders of insurance or ACORD 28 Certificates. One of the most significant pieces of litigation surrounding the World Trade Center stems from the fact that the entire billion dollar-plus transaction was closed based on a binder of insurance placed with multiple carriers. In order to construe the coverage under the policy, including whether there was one act of terrorism or multiple acts, the court was forced to construe the binder because the insurance policies were never issued. Lenders, therefore, are more likely to require policies prior to the closing of major transactions.
There also are additional insurance endorsements and insurances being required in order to close transactions. The following is a representative example of the types of coverages:
(a) extended coverage for business and rental interruption insurance;
(b) leasehold insurance to cover financial loss caused by the termination of a favorable lease;
(c) extended coverage for debris removal;
(d) extended coverage for loss of income by prevention of ingress and egress or act of government;
(e) extended coverage to cover cost of continuing operations in other locations;
(f) extended period of indemnity after reconstruction to provide time to obtain new tenants;
(g) business interruption caused by damage from falling debris (cover physical damage as well as inability to access property);
(h) demolition and increased cost of construction due to enforcement of laws requiring the building to be reconstructed to a higher standard than applicable prior to loss (e.g. ADA);
(i) utility interruption; and
(j) contingent business interruption to cover loss cause by inability to continue business due to loss at a supplier or customer location.
 
VIII. Conclusion.
Insurance provisions contained in documents require careful drafting and a careful analysis of the ever changing techniques used by insurance companies. An important source of information is the Insurance Service Organization located in New York. The ISO is a non-profit organization which specializes in the drafting of insurance forms. ISO forms are available to landlords counsel for review and will contain the most current updates of types and kinds of insurance coverage. The forms frequently include interpretive comments, which will permit landlords counsel to understand the insurance requirements.
It is impossible to say what the effect of September 11, 2001, will bring on the insurance industry. This is a book that continues to be written with the remaining chapters to unfold based on economic conditions, potential acts of future terrorism, and future acts by the government.
It goes without saying that the review by insurance professionals of loan documents is important, if not required. However, this does not replace the careful analysis by the landlord and their counsel, of their documents, the policies, the certificates, and of the underlying documents in order to make sure that the insurance requirements make sense in the context of each particular transaction.

ACORD TM EVIDENCE OF COMMERCIAL PROPERTY INSURANCE
DATE (MM/DD/YYYY)
 
THIS IS EVIDENCE THAT INSURANCE AS IDENTIFIED BELOW HAS BEEN ISSUED, IS IN FORCE, AND CONVEYS ALL THE RIGHTS AND PRIVILEGES AFFORDED UNDER THE POLICY.

PRODUCER NAME, CONTACT	Phone	COMPANY NAME AND	NAIC NO:	
PERSON AND ADDRESS	(A/C. No. Ext):	ADDRESS	 	
	 	 	 	 	
	FAX	 	 	 	
	(A/C. No.	 	 	 	
	 	 	 	 	
	E-MAIL	 	 	 	
	ADDRESS	 	 	 	
	 	 	 	 	
CODE:	SUBCODE:	IF MULTIPLE COMPANIES COMPLETE	
		SEPARATE FORM FOR EACH	
	 	 	 	 	
AGENCY	 	 	 	 	
CUSTOMER ID #:	 	 	 	 	
	 	 	 	 	
NAMED INSURED AND ADDRESS	LOAN NUMBER	  POLICY NUMBER	
	 	 	 	 	
		EFFECTIVE	EXPIRATION	CONTINUED UNTIL	
		DATE	DATE	TERMINATED IF	
				CHECKED	
	 	 	 	 	
ADDITIONAL NAMED INSURERS)	THIS REPLACES PRIOR EVIDENCE DATED:	

PROPERTY INFORMATION (Use additional sheets If more space Is required)
LOCATION/DESCRIPTION
COVERAGE INFORMATION CAUSE OF LOSS FORM   BASIC   SPECIAL   OTHER

COMMERCIAL PROPERTY COVERAGE AMOUNT OF INSURANCE: $ *	DED:	
		YES	NO	 	 	 	
	 	 	 	 	 	 	
		 YES	 NO	 	 	 	
	 	 	 	 	 	 	
 BUSINESS INCOME / RENTAL VALUE			 If YES, indicate amount of	
				insurance on properties	
				identified above: $	
	 	 	 	 	 	 	
BLANKET COVERAGE			If YES, indicate amount of	
				insurance on properties	
				identified above $	
	 	 	 	 	 	 	
TERRORISM COVERAGE			Attach signed Disclosure	
				Notice / DEC	
	 	 	 	 	 	 	
  IS COVERAGE PROVIDED FOR "CERTIFIED			If YES,	SUB LIMIT: 	DED:	
  ACTS" ONLY?	 	 	 	 	 	
	 	 	 	 	 	 	
  IS COVERAGE A STAND ALONE POLICY?			If YES,	LIMIT: 	DED:	
	 	 	 	 	 	 	
  DOES COVERAGE INCLUDE DOMESTIC			If YES,	SUB LIMIT: 	DED:	
  TERRORISM?	 	 	 	 	 	
	 	 	 	 	 	 	
COVERAGE FOR MOLD			If YES,	LIMIT: 	DED:	
	 	 	 	 	 	 	
MOLD EXCLUSION (If "YES", specify	 	 	 	 	 	
organization's form used)	 	 	 	 	 	
	 	 	 	 	 	 	
REPLACEMENT COST	 	 	 	 	 	
	 	 	 	 	 	 	
AGREED AMOUNT	 	 	 	 	 	
	 	 	 	 	 	 	
COINSURANCE			If YES,	%	 	
	 	 	 	 	 	 	
EQUIPMENT BREAKDOWN (If Applicable)			If YES,	LIMIT:  	DED:	
	 	 	 	 	 	 	
LAW AND ORDINANCE	- Coverage for loss			If YES,	LIMIT:  	DED:	
	  to undamaged	 	 	 	 	 	
	  portion of	 	 	 	 	 	
	  building	 	 	 	 	 	
	 	 	 	 	 	 	
	- Demolition Costs			If YES,	LIMIT:  	DED:	
	 	 	 	 	 	 	
	- Incr. Cost of			If YES,	LIMIT:  	DED:	
	  Construction	 	 	 	 	 	
	 	 	 	 	 	 	
EARTHQUAKE (If Applicable)			If YES,	LIMIT:  	DED:	
	 	 	 	 	 	 	
FLOOD (If Applicable)			If YES.	LIMIT:  	DED:	
	 	 	 	 	 	 	
WIND/HAIL (If Separate Policy)			If YES,	LIMIT:  	DED:	
	 	 	 	 	 	 	
PERMISSION TO WAIVE SUBROGATION PRIOR	 	 	 	 	 	
TO LOSS	 	 	 	 	 	

REMARKS - Including Special Conditions (Use additional sheets If more space is required)
 
CANCELLATION
THE POLICY IS SUBJECT TO THE PREMIUMS, FORMS. AND RULES IN EFFECT FOR EACH POLICY PERIOD. SHOULD THE POLICY BE TERMINATED, THE COMPANY WILL GIVE THE ADDITIONAL INTEREST IDENTIFIED BELOW     DAYS WRITTEN NOTICE, AND WILL SEND NOTIFICATION OF ANY CHANGES TO THE POLICY THAT WOULD AFFECT THAT INTEREST. IN ACCORDANCE WITH THE POLICY PROVISIONS OR AS REQUIRED BY LAW.
 
ADDITIONAL INTEREST
NAME AND ADDRESS	LENDER SERVICING AGENT NAME AND ADDRESS	
	 	 	
	MORTGAGE	AUTHORIZED REPRESENTATIVE	
	LOSS PAYEE