Insurance Quotes and Coverages: A Conversation with CWCapital’s George O’Neil III and Harbor Group’s Emily Rasmussen

MBA CREF Associate Director Kelly Hamill interviewed Emily Rasmussen, Managing Director of Business Strategy with Harbor Group Consulting, and George O’Neil III, Managing Director with CW Financial Services LLC, about the insurance market during the coronavirus pandemic.

Rasmussen develops and oversees Harbor’s internal processes and technology platforms. Her role includes managing company analytics procedures, ongoing staff training/development, needs-based process integration for individual clients both new and existing, technology systems development and tailoring of procedural and technology platforms in parallel with evolving market and regulatory expectations.

O’Neil is responsible for all of CW Financial Services LLC’s corporate risk exposures. He was formally trained as a commercial insurance underwriter by Chubb & Son Inc. and over an eight-year period held successively more responsible positions with other firms in commercial property and casualty underwriting to include line underwriter, supervisor, underwriting manager and product executive, ultimately serving as head of International with AIG/Lexington Insurance Co. and later division head of Diversified Property for RLI Insurance Co.

KELLY HAMILL, MBA: Since arriving to the U.S., COVID-19 has raised numerous important questions about insurance. Can you highlight some of the challenges and questions raised for property owners and lenders?

EMILY RASMUSSEN: Agencies, lenders, B-piece buyers and rating agencies rely on insurance as a risk management tool both to cover losses and to create consistency in risk mitigation across an assets credit risk profile; COVID-19 has added a layer of complexity because losses attributable to unforeseen business income volatility are not well addressed in most existing insurance programs.

This volatility, combined with the lack of available coverage at cost effective premium rates has made credit committees both eager to rein in borrower reserves on existing loans and hesitant to lend without a monetized solution. This means borrowers are having difficulty satisfying their obligations as set forth in their existing loan agreements, and despite low interest rates may have difficulty refinancing or obtaining new financing in a cost-effective manner. In light of this trend, lenders are looking to control mechanisms, whether via insurance or some combination of insurance and underwriting, to stabilize the underwriting on cash-flow volatile assets. Lenders are also concerned about changes in market expectations in the next twelve months that may make standard risk mitigation today less risk averse in relation to the overall market a year from now.

When considering insurance as a control mechanism, lenders are challenged with addressing the questions, “did borrower have eligible coverage at the outset of the pandemic” and/or “does borrower have eligible coverage for a similar event going forward.” The short answer for both questions is “maybe” and “probably not,” respectively. There have been several discussions on whether Business Interruption coverage, as presented under the standard ISO form, will respond to COVID losses in the absence of traditional physical damage the property, further caused by a covered peril.

As claims continue to develop and are litigated, many insurance carriers are in a holding position with respect to providing virus-related coverage; and, while Harbor has reviewed a number of ad hoc policy endorsements that offer virus-related coverage, these remedies are not widely commercially available and provide restrictive sub-limits, many which are de minimis when compared to actual losses.   

Looking forward, lenders can expect to see the following unfold in the insurance market:

— Limited carrier availability in certain asset classes.

— As more carriers restrict their capacity, premium pricing will surge due to the imbalance of supply vs demand. Prior to the COVID crisis, the insurance industry entered a hard market with increasing premiums, less advantageous terms to insureds/borrowers and decreased capacity. Of course, COVID-19 is making everything drastically worse.  The 5-15% premium increases that were more common in the property market have now turned into 10-25% increases, or higher percentages for properties that are prone to catastrophic loss. 

— To offset increased premium costs, borrowers will be asking for lower limits and increased retentions/large aggregate retentions.

— There will be more alternative risk transfer (captives, healthcare insurance cooperatives, risk purchasing groups).

— An increase in exclusions and coverage limitations for things like virus, communicable disease, bacteria, microbes, pandemic and outbreak.

— Mandatory risk management requirements/warranties in order to secure and retain coverage.

Given the nature of the disease and widespread impacts, questions around pollution and microbes are particularly relevant.

HAMILL: George, can you discuss how you view the current dynamics as a special servicer often taking title to properties and managing risks like these and others?

GEORGE O’NEIL III: Workout strategies continue to be the focus of asset management and the controlling class representative. However, if an asset is ultimately foreclosed on, in accordance with the servicing agreement, a special servicer may often direct the insurance placement through an insurance broker.  Professional property managers in today’s market are increasingly well equipped and adapting to the local and national guidance regarding PPE and social distancing safeguards for the various classes of commercial real estate. 

As a national special servicer, CWCapital Asset Management engages a range of property managers based on the asset, occupancy and property location, with each property manager required to adapt to local governmental regulations.  Major concerns are being voiced by insurers providing coverage and the potential risks arising from reduced occupancy, possible exposure to the virus and physical maintenance of fire and life safety systems. 

In some instances, insurers are requiring updates and completion of questionnaires that detail the extent and controls that are in place for security, sprinkler systems, ongoing monitoring and maintenance of building temperature. All are well established mitigants for properties that are offering limited services with potentially large areas being unoccupied during the ongoing pandemic.  Insurers are keenly aware of the risks and as major programs renew, requests for periodic status reports and updates of how the properties are being maintained are provided.

HAMILL: Emily, any thoughts to add from your perspective helping lenders to ensure that borrowers and property’s insurance is compliant and appropriately covering insurable risks?

RASMUSSEN: The reality is insurance as it exists in the market today may not be a complete fix for most COVID-related concerns, because carriers consider it an uninsurable loss. In the absence of insurance, lenders will likely need to rely on legal backstops such as recourse, guarantees and sponsor indemnities to bridge any potential gaps in coverage.

For example, a lender may identify gaps in existing coverage and rather than attempt to resolve them by requiring borrowers to obtain costly endorsements, lenders may (upon evaluation of borrower’s creditworthiness) build in a borrower guarantee to cash cover any losses attributable to those gaps in coverage, and build in servicing mechanisms to handle the cash as insurance proceeds would be in the event of a covered loss.

Harbor is actively monitoring the insurance market for new and creative solutions addressing COVID specifically.  In the interim, we recommend that lenders maintain an open dialogue with their borrowers should any virus-related disturbances occur at any of the collateral properties. 

It is important to note that all final confirmation regarding business interruption coverage, related to COVID-19 specifically, must be provided by the carrier, as claims may have to be filed to see if there is even a foothold for coverage.

HAMILL: George, how does the narrowness or ambiguity of exclusion language in situations like these impact a policyholder’s ability to recover or successfully see a claim paid out? 

O’NEIL: Let me say from the start that I will leave the legal issues to the courts, since that is where ambiguous contract wordings will ultimately be decided. However, as a former commercial insurance underwriter for over 20 years leading divisions for major insurers and as a corporate risk manager for over 15 years, I know that underwriting intent at the time of policy issuance and what is finally paid by the insurer or that results from arbitration/mediation/litigation can produce a very different outcome years later and be quite different from what the underwriter “thought” was covered by the policy.  It is essential for both the insurer and insured to have clear language in their policies, yet when events such as COVID-19 occur, the underwriter may very well view the coverage provided by the policy very differently than the risk manager. As many readers are aware, businesses have been required to shut down or operate under limited capacity for months due to orders by civil authority. 

A great deal of discussion is taking place around losses as COVID-19 relates to loss of revenue. This issue has captured the attention of many in the industry, especially whether coverage is provided under typical commercial real estate policies for loss due to civil authority, viruses and similar events. 

As is often the case with insurance, it depends on the actual policy that was issued and the intent of the parties. Very few, if any, underwriters offer loss of income coverage absent direct physical loss or damage due to an insured peril. For that matter, very few underwriters would ever offer stand-alone business income coverage if they did not also provide the first party direct property insurance coverage, and even fewer offered coverage for virus, diseases or pandemics. Unfortunately, few commercial real estate owners have the time or experience to read insurance policies, leaving that to their insurance brokers or possibly their attorneys. 

From a practical standpoint, most insureds assume when a policy states that it covers “all risk” of direct physical loss that would include being shut down or severely restricted due to a government lockdown. Only after the business is dealing with a local order to shutdown do they become aware of any limitations, conditions or exclusions. Typically only after submitting a claim, the insured potentially will learn there is no coverage provided for the economic loss as there was no direct physical loss, to trigger the damage requirement and/or there are exclusions for viruses, and contamination.

To your point, depending upon the contract language and precision used by the underwriter, it may not be clear that the loss is excluded.

HAMILL: George, the language around exclusions like these clearly seems to not be static. What changes are you seeing or do you expect to see in policies post-COVID-19? What are some potential issues that are or are likely to be decided by the courts?

O’NEIL: Going back even to the 1980’s, insurers have been dealing with pollution, contamination and virus exposures. In many instances, insurers seek to exclude pollution, contamination, disease, mold and viruses. In other instances, selected insurers seek to define, sublimit and restrict the losses resulting from contamination, pollution and viruses to a very narrow and specific range of exposures. The approach taken by many insurers is to develop very detailed “pollution exclusions” that list a broad range of conditions and exposures that are not and were not intended to be covered by the policy. 

Concurrent with the evolution of exclusions, a specialty market developed focusing on environmental and even losses arising from disease exposure to respond to coverage that was excluded from standard forms, especially in response to legislation and increased obligations of property and business owners. In the past decade, we have seen outbreaks of SARS and Ebola. Although insurance policies contained exclusions for pollution and contamination, after the SARS event in 2003, insurers once again sought to “clarify” their intent and doubled down on the wording to exclude communicable diseases and viruses from coverage.

In 2006, some insurers adopted Insurance Services Office Inc. virus or bacteria exclusion endorsements that specifically excluded “loss or damage caused by or resulting from any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness or disease.”  

Depending upon the policy that is issued, the underwriter, and how the insurer issued the contract, it may not be clear that a virus or contamination loss is excluded and reasonable people can disagree on the meaning of “coverage,” “direct physical loss,” “virus” and “pollution and contamination.” Especially when the survival of a company is at stake, views can become very polarized either in favor of one position over another. Reasonable people can disagree on the meaning of “coverage,” “direct physical loss,” “virus,” and “pollution and contamination.” Ultimately, the courts will determine what the contract actually means, though the process is often not swift and the direct and indirect cost to all involved may be great.

HAMILL: Emily,have you seen much thus far that you expect to impact future loan covenants? Have there been other events of this type, I presume with a smaller scope that have significantly impacted insurance policy language, coverage and exclusions that you can draw upon as examples?

RASMUSSEN: Following the events of September 11, 2001, the insurance and financial industries were confronted with addressing a new class of catastrophic event. Similar to the COVID pandemic, the scope of expected losses had not been fully understood nor underwritten prior the actual event.

At the time, carriers began to specifically exclude acts of terror from policies while lenders were specifically requiring such coverage be included. This led to the U.S. government passing the Terrorism Risk Insurance Act (TRIA, and subsequent revisions) to require insurance companies to offer terrorism insurance with a government backstop should certain conditions be met. This legislation provided the groundwork for both the insurance industry to backstop catastrophic loss from a terrorist act and real estate markets to help cover this critical risk. 

Similarly, the proposed Pandemic Risk Insurance Act (PRIA), should it pass, would provide backing to participating carriers offering virus-related coverages on a go-forward basis and could certainly move the needle on the future of lender underwriting criteria and insurance requirements.

Additionally, as government mandates continue to be imposed across the country, it is possible that insurance carriers and the courts may change their views on how to recover a business interruption claim related to COVID.

HAMILL: George, you’ve been a member of MBA for a long time and involved with Insurance Conclave event we host each fall that explore issues such as these and many others. Can you describe the event and peer group and why you’ve enjoyed actively participating? 

O’NEIL: As one of the largest special servicers, CWCapital Asset Management LLC and our affiliates are a diversified real estate service provider to the commercial real estate sector. From the very first conclave MBA hosted in CWCapital Asset Management’s Bethesda, Md., office in 2013, our commitment to risk management and insurance issues has been significant.   

When the Insurance Conclave was envisioned, the goal was to bring together a group of peers and practitioners whose role it is to manage the insurance and associated risk management for commercial real estate lenders. Insurance is often not the first consideration when a loan is originated, however non-compliant or inadequate coverage at the time of a major loss could result in severe economic impact and loss. We believe if all stakeholders are aware of the issues that others face, it will improve the process, certainty, and overall understanding of all industry stakeholders.  

The Insurance Conclave is a forum where senior risk, insurance and compliance officers of leading lenders and servicers come together to discuss insurance market trends, complex coverage challenges, best practices for compliance and claims management. We believe that increased awareness leads to improved insurance coverage requirements, both in clarity of language, market sustainable insurance policy limits and ultimately lower cost to the borrower. In each case the result is a more efficient process and loan performance.   

Requiring borrowers to obtain coverage that is not needed, unavailable or too costly benefits no one, and is detrimental to all parties. The Conclave is that special forum where participants can share common challenges and potential solutions. As the commercial real estate industry continues its move into technology, we are developing tools to assist, making sure insurance and compliance covenants are defined in the software such as our affiliate RealInsight.(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, atmtucker@mba.org.)