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In the event that a commercial mortgage loan ends up in default,the lender must be able to realize on the collateral upon theexercise of remedies. If the collateral is destroyed or severelydamaged by, for example, a flood or an act of terrorism, the valueof the underlying asset will be greatly diminished or, in somecases, fundamentally eradicated (save for the value of the land).Insurance plays a crucial role in protecting the lender from such aloss.

Federal programs in the U.S. have made insurance more readilyaccessible to protect real property in the circumstances mentionedabove, specifically, the Terrorism Risk Insurance Program (TRIP) and theNational Flood Insurance Program (NFIP).

These programs enable flood and terrorism insurance to be widelyavailable at realistic price points by ensuring that the amount ofthe premiums payable for such insurance remains at a level that aborrower can afford, which in turn preserves the underwritteneconomics of the loan transaction.

Without further governmental action, both TRIP and NFIP were setto expire—at the end of 2020 and at the end of last year,respectively—with no alternative scheme in place. The failure tohave renewed these programs most likely would have disruptedstability not only in the insurance markets, but also in the realestate markets overall, including the commercial mortgage lendingmarkets.

To the relief of insurance companies, property owners, andlenders, recent bipartisan congressional legislation reauthorized TRIP and NFIP. Thereauthorizations are part of the $1.4 billion omnibus spendingpackage, which funds the federal government through 2020, known asthe "Further Consolidated Appropriations Act,2020" (Appropriations Act). These reauthorizations, importantly (ifonly temporarily, particularly the case of the flood insurancereauthorization) provide consistency and stability in real estatemarkets that are highly dependent on these programs.

Terrorism Insurance

TRIP, which was established after the 9/11 attacks and theperiod of disarray in the insurance markets that ensued thereafter,requires certain private insurers to offer coverage against acts ofterror that otherwise would be too risky to provide without federalassistance. Under TRIP, the federal government acts as a backstopto private insurance providers in the event insurance proceeds arerequired to be paid out under claims due to a terrorist attack. Apredetermined formula is used to calculate the amounts of proceedsthat each of the government and the insurer must provide.

Under TRIP, the U.S. federal government guarantees that if thedamage caused by a terrorist act (which must be certified as suchby the Secretary of the Treasury) is over a certain thresholdamount, it will pay for most of the damages, up to the "programcap" of $100 billion annually. The cap also applies to privateinsurers—i.e., insurers are not required to pay for losses due toterrorist acts in excess of $100 billion annually. Although theprogram has never been triggered, it offers an important sense ofstability to the real estate and lending markets.

Prior to the passing of the Appropriations Act, commentatorswarned of the potential impact that a failure to renew TRIP wouldhave on the market. Warnings of substantially inflated premiums anda lack of coverage options (or a total lack of the existence ofcoverage) seemed plausible. The catastrophic events of 9/11displayed the unfathomable damage that an act of terror can cause.Without the government's guarantee, the risk would be too great forprivate insurers to carry at costs that property owners couldafford. Under the Appropriations Act, TRIP will now expire on Dec.31, 2027.

Flood Insurance

The NFIP is the national flood insuranceprogram that was instituted by the Federal Emergency ManagementAgency (FEMA) in 1968 to cover vulnerable properties from flooddamage, which was often excluded from property insurance coverage.Federally regulated lenders must require that flood insurance beobtained on any property that they lend on and that is located inan area identified by FEMA as a special flood hazard area (floodzone). The Biggert-Waters Flood Insurance Reform Act, whichpreviously extended NFIP, expired in 2017.

Since then, the U.S. Congress has repeatedly passed short-termlegislative measures that renewed and kept the program afloat. Thecurrent reauthorization of NFIP under the Appropriations Act,although it renews the program for only six months (it is currentlyset to expire on Sept. 30, 2020), provides an important measure ofstability for insurance coverage for millions who own propertylocated in a flood zone. With an uptick in extreme weather eventshitting the United States, both property owners and their lendersincreasingly rely upon flood insurance.

The unpredictability of the availability of this program and thepotential implication of a lapse in coverage forproperties most at risk for flood damage mean that a failure toreauthorize the program could bring sales of such properties to ahalt, or eliminate lenders' willingness to provide mortgage loansencumbering such properties. Either result would leave all partiesthat own or provide financing for flood-prone real property unclearon the value of those assets. For now, however, the markets arestable.

The ability of a property owner and its lender to protect theirrespective interests in real property from losses due to damage ordestruction resulting from floods and terrorism is crucial tosafeguarding the return on their investment. Thus, ensuring thatthe aforementioned insurance coverages remain available to propertyowners/borrowers at premiums that they can afford is of utmostimportance to the stability of real estate markets, including thelending markets, and the economy at large. The passage of theAppropriations Act was an important measure in preserving suchstability, for a time at least.

Jeffrey B. Steiner and Scott AWeinberg are partners at McDermott Will & Emery.John Bauco and Lauren A. Sellman, associates at the firm, assistedin the preparation of this article.

From: PropertyCasualty360