By Charles Anderson
The Problems
Since 11 September 2001, insurance companies have been ceasing to provide "full" terrorism cover as they have been unable to obtain reinsurance cover for terrorist damage which falls outside the Pool Re scheme. Prior to 11 September 2001, insurance companies were able to provide full terrorism cover on the following basis:
- A basic cover capped at £100,000 which the insurance company itself would pay to the insured.
- Reinsurance cover under the Pool Re scheme. Insurance companies became members of Pool Re which would pay out insurance monies for damage caused by fire or explosion attributable to "terrorism". This cover applied only to fire or explosion and by reference only to the Pool Re definition of "terrorism" (principally to overthrow or influence government). The Government agreed with Pool Re to be the ultimate provider of funds in the event of the Pool Re funds proving inadequate.
- Reinsurance cover in respect of terrorist damage that was not covered by Pool Re.
As mentioned above, the current problem is that insurance companies are not able to obtain reinsurance cover for the damage which falls outside Pool Re. For this reason alone, Landlords and Tenants need to consider the necessary lease provisions to reflect the absence of insurance cover. Additionally, Sellers and Buyers of commercial properties should consider the necessary contract provisions in respect of the allocation of risk.
Additionally:
- There were concerns that Pool Re does not cover all forms of terrorism and all damage arising from terrorism.
- Tenants may now seek rent suspension in the event of damage or destruction by terrorism (irrespective of whether terrorism is an insured risk). Insurers appear to be refusing to insure loss-of-rent cover where the rent suspension is triggered by damage or destruction by terrorism.
Lease Provisions
Action to be taken by Landlords
- Where Landlords covenant to insure, the obligation should not extend to cover risks or damage for which insurance cover cannot be obtained on reasonable commercial terms (ie exclude the terrorist damage in respect of which cover is not available).
- There should be a Landlord's break clause giving the Landlord the right to terminate the Lease in the event of damage by terrorism whether or not it is an insured risk.
- Landlords should seek to obtain additional loss-of-rent cover to apply in the event of rent suspension on account of damage by terrorism whether or not it is an insured risk. Normal loss-of-rent cover only applies in the event of rent suspension attributable to an insured risk (rather than the uninsured terrorist risk).
- Landlords should insert provisions whereby the Tenant is obliged to reimburse the premium/a proportion of the premium for paying Pool Re cover and additional loss-of-rent cover.
- Landlords should consider protective provisions on rent review particularly where the Tenant is subject to an (onerous) obligation to reinstate at its own expense as a result of insurance cover not being available for the terrorist damage.
Action to be taken by Tenants
- Tenants should ensure that they are not obliged to reinstate (either specifically or under a repairing covenant) on account of the terrorist damage falling outside the insured risk qualification to the Tenant's reinstatement or repairing obligation. There should be an express provision that the Tenant is not obliged to reinstate terrorist damage irrespective of whether terrorism is an insured risk.
- Where Tenants covenant to insure, the obligation should not extend to cover risks or damage for which insurance cover cannot be obtained on reasonable commercial terms (ie exclude terrorism).
- Where Landlords covenant to insure, Tenants should closely examine the detail of the obligation (particularly the definition of insured risks) to identify whether terrorist damage is covered by the policy and the Landlord's reinstatement obligation. If terrorist damage is excluded, Tenants should seek an express Landlord's reinstatement obligation.
- There should be a Tenant's break clause giving the Tenant the right to terminate the Lease in the event of damage by terrorism whether or not it is an insured risk.
- Tenants should ensure that rent suspension is triggered by terrorist damage whether or not it is an insured risk.
- If Tenants have to accept onerous reinstatement obligations (for example, to reinstate terrorist damage without any insurance cover being available), Tenants should insist upon an initial rental discount and an express assumption of the obligations as terms of the hypothetical lease on rent review.
Sale Agreements
On the sale of a commercial investment property, the Seller will generally insist that the risk of damage to the Property passes on exchange. In respect of insurable risks, the Buyer will normally insist upon provisions whereby:
- The Seller is obliged to maintain insurance cover (particularly in accordance with obligations under occupational leases) until completion.
- The Seller provides the Buyer with full details of the terms of the policy.
- The Seller procures that the Buyer's interest is noted on the policy.
- The Buyer is entitled to direct the Seller either to apply the insurance monies in the reinstatement of the Property or to pay the insurance monies to the Buyer on completion subject to the Buyer indemnifying the Seller in respect of any liability to the occupational tenants in respect of the reinstatement of the Property.
Where the Property is not covered against terrorist damage and the Seller is insisting that risk passes at exchange, the Buyer should consider:
- insisting upon the right to terminate the Agreement if there is terrorist damage between exchange and completion, or
- simultaneous exchange and completion.
A funder may well refuse to advance funds on completion if there has been post-exchange uninsured terrorist damage.
The Current Position
Pool Re continues to operate but if Landlords or Tenants are to require their insurers to provide Pool Re cover:
- The insured will ultimately bear the cost of the premium.
- The insured must elect for all its properties; it is not possible for an insured to require its insurer to procure Pool Re cover on a property by property basis.
- The retention of £100,000 continues to apply.
- Pool Re covers buildings/structures, other property (including contents), business interruption and book debts.
The Government announced on 23 July that:
- Pool Re cover would be extended from just "fire and explosion" to an "all risks basis" including impact by aircraft, contamination and flood damage.
- As from 1 January 2003 there would be changes in the financing of Pool Re and the transparency of its governance.
Although the extension of the Pool Re cover to an "all risks" basis means that Pool Re now covers the risks which the insurance companies, originally, reinsured and, recently, withdrew from reinsurance, it should be noted that the Government has not extended the definition of "Terrorism". Even if there is damage by one of the extended risks within Pool Re, cover will not be available under Pool Re if the damage was caused by terrorism whose object was not to overthrow or influence Government. It is still only damage by a terrorist intending to overthrow Government that is covered by Pool Re.
Insurers are continuing to exclude cover for the wider definition of "Terrorism". Accordingly, there is a gap between the Pool Re cover for all risks caused by terrorism as narrowly defined and the Insurers' cover which excludes risks caused by terrorism as widely defined.
It is likely that Pool Re premiums will double to a significant level.
The insurance market appears to be refusing to cover loss-of-rent where the trigger for rent suspension is terrorist damage.
Surveyors are already perceiving an impact in the market-place in that:
- Tenants are refusing to accept new leases under which they carry the risk of reinstating uninsured terrorist damage.
- Tenants are demanding fairly substantial premiums to take assignments of existing leases under which they carry the risk of reinstating uninsured terrorist damage.
- Tenants are seeking discounts at rent review on the ground that an obligation to reinstate an uninsured risk is an onerous term; this onerous term will be assumed as a term of the hypothetical letting on the basis of which the reviewed rent is assessed.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.
