Terror Insurance Decision Will Affect CMBS Credit

Many commercial mortgage-backed securities will suffer if a federal backstop for terrorism is allowed to expire at the end of this year, Fitch Ratings reported this week. The Terrorism Risk Insurance Extension Act (TRIA) provides insurers with reinsurance to help cope with catastrophic losses in the event of a terrorist attack. A bill to extend the act for 15 years beyond its current sunset of Dec. 31, 2007, recently passed a House vote but hasn’t garnered full Congressional approval.

If the act is allowed to expire as scheduled, rating agencies will be compelled to review many new and existing CMBS transactions, according to Fitch. The end result could be a broad reduction in lending, greater defaults and downgrades across the broader CMBS universe.

The White House and others opposed to a TRIA extension contend the insurance industry should develop its own solution to the need for terrorism insurance. TRIA’s proponents, however, say the unpredictable nature and devastating potential losses involved make terrorism risk uninsurable without government participation.

If the act isn’t extended or replaced, proponents argue, insurers will cease to provide terrorism insurance at a reasonable cost. Because many CMBS loans require terrorism risk coverage, owners who are unwilling or unable to pay for that coverage in a post-TRIA insurance market could be deemed non-compliant on their loans.

“As a subset of the commercial mortgage lending industry, the CMBS industry would be directly and immediately affected if TRIA were not in place,” Fitch analysts stated in a report published Oct. 9. “Fitch’s methodology for rating CMBS transactions assumes insurance coverage, including casualty resulting from terrorism, for the full loan amount. In fact, Fitch has declined to rate some transactions which it believed did not have adequate terrorism insurance.”

On Oct. 10, the RAND Corp. published a report indicating the federal backstop for terrorism insurance has a positive impact on the insurance marketplace. That report, “The Federal Role in Terrorism Insurance: Evaluating Alternatives in an Uncertain World,” concludes that the proportion of property insurance properties with terrorism coverage is higher with the backstop, and uncompensated losses are lower.
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