The shattering events of 9/11/01 created nearly instantaneous havoc in the commercial facilities insurance market.Before that fateful day, the risks of losses due to terrorism were considered so low that they were automatically covered in most insurance policies. That literally changed overnight. “Insurers immediately began sending out cancellation notices,” says Rich Chicotel, chief financial officer at San Francisco-based Shorenstein Co. LP, which owns and operates a number of high-profile buildings across the country, including the Bank of America Building in San Francisco and the John Hancock Center in Chicago.The attacks of 9/11 have left the commercial insurance industry in a state of upheaval, facing astronomically high payouts while still trying to service unaffected policyholders. A year after the attacks, the New York City-based Insurance Information Institute estimates that the total insurance loss will ultimately climb to about $40.2 billion.“9/11 is not only the biggest insured catastrophe ever; it is the most complex,” says Gordon Stewart, Institute president. “The vast majority of claims for homes and autos have been paid, but commercial claims are more varied and complicated. While many have been helped, this recovery process will take years.”Closer ExaminationIn May, the U.S. Congress Joint Economic Committee chaired by Congressman Jim Saxton (R-NJ) released a study, Economic Perspectives on Terrorism Insurance, which examines the market for terrorism insurance in the United States. The study, which discusses the economic implications of the cost and availability of such insurance, found insurance companies now are routinely excluding or limiting coverage for terrorist acts from the policies they issue. When it is provided, it is expensive, hard to find at needed coverage levels, and, sometimes, impossible to obtain.According to the report: “The first reaction of the insurance industry following the 9/11 attacks was to reassure policyholders and investors that the industry had sufficient reserves to pay claims. This reassurance injected a sense of economic security that the economic damage of the attacks would be repaired … that long-term economic impact would be mitigated to a certain degree. Soon after the attacks, the insurance industry took another step with long-term implications: It began to withdraw coverage for future losses caused by terrorism. Insurers decided they could no longer write policies that automatically covered losses by terrorist acts.”Terrorism insurance has fallen into the same realm as earthquake, wind, and hurricane coverage – existing as a separate policy offered by only a handful of carriers. It, however, poses great actuarial challenges in terms of pricing.Insurers generally use sophisticated actuarial models to set premiums. These models are based on two factors: the probability of occurrences and the size of losses. Natural disasters, such as hurricanes and earthquakes, have a long, recorded history that permits insurers to predict aggregate potential losses over time. Terrorism, by comparison and its limited historical basis in the insurance industry, represents potentially unlimited losses with unpredictable frequency.“The possibility of an event the scale of 9/11 within the United States was not considered by insurers,” says Jack Gibson, president of the Insurance and Risk Management Institute (IRMI) in Dallas. “Previously, the prevailing worst-case scenario loss estimate of most insurance professionals was based on a crash of a single airliner into a metropolitan area. Thus, the move to impose terrorism exclusions is at least somewhat understandable.”Gibson notes that IRMI’s insurance industry contacts have said most businesses are still not purchasing stand-alone terrorism coverage. “They are comparing the premiums being quoted to the values exposed and their perceptions of the risk their properties will be targeted, and they are simply deciding that the coverage isn’t worth the money,” he explains. “A key exception to this is businesses that have other reasons to buy the insurance, such as requirements from lenders or investors.”Downside of RenewalsTerrorism insurance aside, insurers also have made drastic changes in how they are approaching renewals for commercial property insurance policies. Real estate industry sources involved in insurance and risk management activities report that, in the past year, coverage limits have plummeted, while prices have risen sharply.“Since 9/11, the insurance market has increased premiums, reduced capacity; mandated exclusions, such as terrorism and mold; reduced coverage; and mandated higher deductibles and self-insured retentions,” notes Maureen Ehrenberg, national director of property management for Grubb & Ellis in Northbrook, IL, and a BOMA (Building Owners and Managers Association) board member.While Grubb & Ellis does not own, nor is it responsible for insuring any of the buildings it manages, Ehrenberg says the company continues to assist its clients in securing insurance and/or insurance proposals through its Master Real Estate Program, a specialized program designed for G&E clients through a nationally recognized insurance broker. Additionally, new property and facilities management agreements also include terrorism (and mold) indemnity language more favorable to Grubb & Ellis.At Shorenstein, Chicotel just completed his company’s first property insurance and liability renewals since the 9/11 attacks. As most all property insurance policies, Shorenstein’s renews annually every April 1. He and the company’s brokers, Marsh Inc., a New York City-based risk and insurance services firm, began the process shortly after the attacks.“We marketed our program to 200 carriers in the United States and Europe. Insurance companies are taking a much more careful approach to underwriting risk,” he says. “In the end, our coverage shrunk by 80 percent this year in fire insurance. Our earthquake coverage shrunk by 50 percent, as did our wind coverage. The pricing, however, went up by hundreds of percents. We’re paying a lot more money and receiving a lot less coverage.”Chicotel says that this reduction in coverage has created snags with various entities, including Shorenstein’s lenders, which have required limits of coverage written into agreements. “We don’t have as much coverage as we like. We don’t have as much coverage as they’d like. We’re trying to fill in the holes as best as we can,” he says. “I know of people in the industry who can’t get coverage. It’s a bad scenario that’s going to have to play itself out.”Researchers at The Real Estate Roundtable in Washington, D.C., conducted a survey in August that revealed real estate transactions worth nearly $10.5 billion have been delayed or cancelled due to the ongoing lack of terrorism insurance coverage and reduced limits on other coverage. Survey respondents, who are senior executives at leading real estate ownership, development, and lending firms, reported project delays and cancellations in 13 states. The survey also reveals that the office sector is the property type most affected by the lack of terrorism insurance, outpacing delays and cancellations in the apartment and retail sectors by a 3-to-1 ratio.Basis for UnderwritingThe experts at IRMI dub this current state of affairs a “hard insurance market” and believe it will continue through next year. A House-Senate conference committee has been named to negotiate a compromise between the two versions of existing terrorism legislation, which has received strong support from President Bush.In the meantime, the real estate industry finds itself assessing insurance needs and wondering whether or not insurers jumped on the disaster bandwagon in the 9/11 aftermath.“One viewpoint is that the commercial insurance market took advantage after 9/11,” Ehrenberg says, noting that the insurance market was starting to “harden” before 9/11. “It most likely would not have ‘hardened’ so drastically if it were not for 9/11. Even risks with favorable loss history are experiencing double and triple insurance premium increases with higher deductibles and self-insured retentions. The insurance industry appears to be underwriting based on industry risk and exposure, rather than individual risk and exposure.”As a result, building owners, managers, and developers must assume more risk in an effort to stabilize insurance costs to remain economically competitive.Robin Suttell, based in Cleveland, is contributing editor at Buildings magazine.