Insuring Terrorism - Who Pays?

Why is cover so important now?

The threat of substantial damage or destruction to commercial property by terrorism has been a factor in the United Kingdom over the last half-century or more. London in particular has been exposed to the activities of the IRA, but this has by no means been restricted to the capital, with terrorist outrages witnessed in Birmingham, Manchester and other provincial centres. People in Britain might be said to be not unfamiliar with terrorist attack – so why has the cost of terrorist attack and the threat to property received so much attention recently?

In part this must be because the events of July 7th and bombings in Madrid, Bali and New York have alerted people to a new and potentially far more damaging form of international terrorism but also because the insurance market has suffered severely in the past few years with an attendant impact upon the property market.

The insurance market has understandably sought to minimise its own exposure to terrorist risks over this period and it has traditionally been the case that tenants have borne greater exposure to such risks than landlords. Because of the entirely unpredictable nature of this risk, insuring terrorism has always tended to be dealt with as a further or subsidiary matter in the same way as the risk of damage by flooding, or it has been ignored. The consequences of ignoring these situations can be disastrous however. In the United States, the cost of the events of 11th September 2001 has already run into hundreds of millions of dollars and countries such as Egypt and Indonesia which rely on revenue from tourism have suffered badly from the bombings in Sharm El Sheikh and Bali.

Pool Reinsurance

One response to terrorist attack in the early 1990’s was the establishment of Pool Reinsurance Company. Insurers found that increasingly reinsurers were unwilling to cover their liabilities after a series of costly attacks. As a result, insurers forced a form of terrorism exclusion upon the commercial property market. The exclusion meant in practice that cover from 1993 was limited to £100,000. However the government realised that this was an unworkable situation in the current political climate and negotiated with the insurers for the establishment of a mutual insurance company into which all premiums for additional cover were paid. The government then effectively acted as insurer of last resort after the Pool Reinsurance Company had paid out on up to 10% of the total premiums paid.

Review of how the insurance market is responding:

These days nearly all insurers exclude damage to buildings and consequent losses by terrorism from their policies. The insurers then provide an option to ‘buy-back’ cover for terrorist risks. The difficulty is that until recently the definition of the term terrorism in the exclusion has been wider than that in the buy-back, leaving a gap in the cover provided. Put simply, the exclusion is very wide whilst the buy-back definition is more restricted thus excluding, within the buy back, particular forms of terrorist activity. Examples of activities that have fallen outside of the scope of the buy-back are terrorist activities involving an individual person as opposed to a clearly perceived group; also excluded were activities where the aim is not intended or directed toward the overthrow or influencing of the government. This last element is of particular concern as it has been argued that religiously motivated attacks could fall outside this definition.

In 2003 some of these problems were addressed when Pool Re revised its cover and extended it to include damage by nuclear, biological/ chemical attack. However the larger reinsurers including Pool Re have still not addressed this gap leaving some, if not many policyholders more vulnerable than perhaps they anticipated.

Legislation & Code of Practice for Commercial Leases, developments?

Part of the difficulty of introducing certainty into lease negotiations on the relative negotiating positions of landlord and tenant regarding uninsured risks stems from the absence of statutory requirements in this area. In 2002, a body consisting of representatives of landlords and tenants and the professions that represent them known as the Commercial Leases Working Group published a set of guidelines in an attempt to clarify best practice in lease negotiations. These guidelines included recommendations on uninsured risks with the working group conscious of the sort of catastrophic damage caused by terrorist risks, which may not always be insured.

There has been a growing realisation within the market that it is no longer acceptable for the landlord to allow the tenant to bear the burden of reinstating a property after damage or destruction by an uninsured risk. As a result, the Code of Practice for Commercial Leases has recommended that where a property is damaged by an uninsured risk for which the tenant is responsible, the landlord should permit the tenant to terminate the lease, or else undertake to rebuild the Premises at his own cost. The other main recommendation relating to insuring premises is that the tenant of the whole of a building should be involved in negotiating the appropriate level of cover with both the landlord and the insurer and in effect the market has tended toward a situation where a collaborative approach is perceived as the only viable way forward.

Conclusion:

Whilst there have been some moves toward a more balanced approach in the sharing of liability in these situations, it remains the case that the commercial property sector has not received these recommendations with any significant enthusiasm or take-up. In a survey of commercial property professionals published in 2005 it was noted that the response to, and indeed awareness of, the Code of Practice for Commercial Leases was low with many of those surveyed admitting that they were either unaware of the code or did not habitually use it in negotiating terms. As a consequence there remains considerable divergence in the sorts of terms being negotiated.

The Office of the Deputy Prime Minister indicated [in 2004] that there would be no legislation on many aspects of commercial leasing in the near future but committed to further consultation over a three year period. This follows a consistent approach taken by the government in allowing market forces to dictate trends in lease negotiations, and preferring recommended practices to lead the way. How far this goes toward a balanced sharing of liability between parties remains to be seen.

Parties to commercial lease negotiations should bear in mind that it is not always advisable to force significant liability upon the other party. When negotiating commercial leases, the ‘best practice’ recommended by the Code of Practice on Commercial Leases is first and foremost to anticipate likely outcomes and to devise strategies to minimise both parties’ exposure to unreasonable liability. This may result in parties accepting greater liability than anticipated but, in the long-term may mitigate the risk of protracted disputes in the event of the worst happening.

In seeking suitable insurance cover for terrorist risks property owners should be aware of the potential trap laid open by the narrow definition of most standard buy-back clauses. There are now a limited number of insurance providers who consider altering standard clauses to provide more comprehensive cover – how much this costs is of course dependant upon circumstances and individual insurers’ current policies. Landlords and tenants should also investigate whether or not a party may seek cover for specific risks even where that party is not legally responsible for insuring the premises.

The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. Piper Smith Watton cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.