Without specially adapted real estate
environmental liability insurance covering mold-related damages, the risk
of default on any commercial property is high.
BY CHARLES L. PERRY JR.
Posted July 4, 2007
The success of the insurance industry in managing its
mold related loss exposure has made it more difficult for borrowers and
mortgage lenders to manage theirs. Fresh from its experience with asbestos
and superfund claims, the insurance industry moved at record speed to
exclude mold losses in all forms of prospective insurance coverage.
Instead of charging higher premiums for the new
source of runaway claims, insurance companies chose to avoid future
exposure and losses by simply excluding coverage. As a result, borrowers,
mortgage lenders, servicers and securitized lenders/investors are now left
uninsured and unsecured for a peril that has proven to make buildings
valueless and create toxic tort liability claims measured in the tens of
millions of dollars on individual properties on a frequent basis.
As of today, few borrowers and lenders have taken
advantage of the full array of risk management options available to them.
However, during this same time frame, thousands of plaintiffs' lawyers,
attended hundreds of "mold is gold" seminars, and by 2002 insurance
companies were desperately looking for a way out of the toxic-mold morass.
Insurance companies issued tens of millions of
mold-related claims exclusions and limitations. In so doing, they
successfully pushed mold losses back into the economy as uninsured losses.
And they did it without reducing their rates.
By 2005, the insurance companies had stopped covering
mold-related losses in virtually every form of commercial insurance
including property, builders risk, general liability and professional
liability policies. Real estate owners and, therefore, their lenders were
left uninsured.
The final resting place for uninsured mold-related
damages in the economy has yet to be determined. But one thing is certain:
These tens of millions of mold-related claims exclusions in property and
liability insurance policies will have a material financial impact on
somebody.
So far, many mortgage lenders, banking regulators and
rating agencies have seemed oblivious to the issue of being unsecured for
a peril with such a substantial loss content.
These same borrowers and lenders have alternatives
available to them today to manage mold-loss exposures. Most have failed,
however, to effectively use them. Many others are not even aware that
solutions exist.
Huge Losses
The Insurance Information Institute
estimates that mold-damage claims cost the insurance industry $3 billion
in 2002 (the year before they started issuing exclusions). That figure
went as high as $12 billion when including toxic tort personal injury
claims. To put mold-related losses into perspective, the total insured
loss from fires in 2002 was $12.6 billion dollars, according to the
institute.
Mold-related damages to property did not disappear
with the insurance coverage. new mold-related damages occur every day, and
the number of specialized mold-remediation contractors has remained
stable. That means there is a significant number of mold related losses
that are no longer insured but still being incurred. Some of these
properties ultimately will end up on the books of the mortgage bankers in
the form of nonperforming loans.
There have been widespread adverse effects of
universal mold-related claims exclusins in wind-and flood- damaged areas.
It is common knowledge that mold can make a building valueless. Borrowers,
lenders, banking regulators and rating agencies that are slow to
acknowledge the effects of insurance exclusions for mold are likely to
regret it. At a time when the mortgage lending and insurance industries
are spending so much time wrestling with the issue of terrorism exposures
and potential losses, mold strikes and average of 10 to 1,000 homes and
buildings every day. Considering the insurance industry's view of loss
exposure, a high frequency loss scenario is much worse than a
high-severity scenario.
For decades, secured lenders have required borrowers
to obtain property and liability insurance. Lenders have consistently
outlined exactly how this insurance should be provided in the loan
covenants.
Risk avoidance is not a risk management alternative
for mortgage lenders or securitized lenders/investors because to avoid
mold risks they would need to stop the deal flow and stop lending money.
Obviously, this is not an option with existing loans, either. Therefore,
lenders will need to rely on risk identification, loss prevention and
innovative environmental insurance products to manage their mold-related
loss exposures or wait for the insurance industry to back into the
marketplace with newly structured mold coverages.
Lenders also need to specifically address mold
exposures in their insurance requirements to close these coverage gaps
between the insurance policies they asked for in the loan covenants and
the coverage actually being provided by the borrowers.
To protect their security interests in property,
virtually all secured lenders require all-risk property insurance. Banking
regulators and rating agencies depend on insurance to be in place when
evaluating the quality risk in a lender's portfolio. These property
insurance policies pay for the replacement of insured buildings and
contents which may be damaged by a wide range of insured perils, including
fire, windstorm, civil commotion, aircraft, smoke, hail, rain, riot,
malicious mischief and explosion. The all-risk property insurance policy
is designed to cover all risk of loss except for those specifically
excluded.
Regulators and rating agencies rely on the underlying
insurance on securitized loans to evaluate the risk quotient of the
lending institution or a portfolio of loans for the secondary market.
However, none of the rating agencies or regulators has captured the
ramifications of universal mold exclusions.
Universal Exclusion
The coverage impact of mold
exclusions is not well-understood by insurance practitioners or lenders
because they have their roots in pollution exclusions. And pollution
exclusions are highly litigated.
The universal exclusion of mold related claims in all
commercial insurance policies, including the builders risk policies
(purchased to cover property damage occurring during construction) and
other property insurance policies, has created a material gap between the
specified insurance required for commercial loans and the insurance
actually provided by the borrower.
Without specially adapted real estate environmental
liability insurance covering mold-related damages (including the cleanup
of mold and related business-interruption expenses), lenders face a
greater risk of default on any property that develops water-intrusion
problems leading to mold.
