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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   April 2008

On the Lookout for Insurance Exclusions

With green building on the rise, risks from mold exclusions to insurance coverage may also increase

Lending on green buildings creates an opportunity for brokers and lenders to enhance their corporate image as sustainable businesses. Other benefits of participating in the environmental movement include creating greater shareholder value, improving recruitment success, enhancing employee morale and having a competitive advantage in lending practices.

Like any sea change in the global economy, however, the green movement introduces new risks for the commercial mortgage industry. Informed brokers and lenders that do not manage the new risks may face an increasing number of nonperforming loans on uninsured properties. Traditional lender risk-management protocols, including the insurance requirements in loan covenants, will not be enough to address the green movement’s new risks.

One primary challenge is the future obsolescence of older buildings that physically cannot be upgraded to green standards in the face of new demand for green office space. To address this new default risk, lenders must add it to their long-term financing underwriting guidelines.

A more-immediate and widespread risk that affects all loans -- but that may affect green buildings disproportionately -- is the impact of universal mold and bacteria exclusions in insurance policies. Green buildings are energy-efficient and use more-sustainable recycled building materials. Therefore, they inherently have a greater chance of developing mold growth and interior air-quality problems than older buildings that used raw wood.

To compound the increased risk in green construction itself, the stakeholders in a project, including the lender, will be uninsured if even part of the damage to people or property involves any amount of mold or bacteria. This is because beginning in 2002, the insurance industry moved to eliminate all coverage in standard insurance policies for any kind of loss associated with mold or bacteria.

Universal exclusions are now in place on commercial insurance policies. Mold and bacteria exclusions have even found their way into mortgage-impairment and bankers’ professional-liability policies, which are traditionally lenders’ last line of defense on their secured loans.

Lenders with insurance-sales operations also face new professional-liability risks for the insurance agents who fail to advise their customers about the far-reaching implications of universal exclusions. Because appropriate insurance for these damages is available at economical premiums, agents who leave a customer unintentionally uninsured are relatively easy targets for a professional-liability claim. To eliminate their professional-liability loss exposure, agents should offer appropriate mold coverage.

Managing water-intrusion and mold risks, including securing proper insurance on a green building, is easy to do and can be relatively inexpensive. It does not necessarily cost more to build and insure a low-risk green building.

Today, mold-related damages disproportionately head to the lending community in the form of nonperforming loans. This is because most lenders don’t require enough insurance to protect their security position from these losses.

There usually is a $25,000 mold-coverage sublimit on a commercial property insurance policy. The problem is the mold sublimit is a fixed amount and is unrelated to the building’s value. Because it is well-documented that mold can make an entire building valueless, a $25,000 sublimit on a loan measured in millions or hundreds of millions of dollars leaves stakeholders and their lenders essentially bare on the property insurance policies, as well.

Brokers and lenders should take a number of steps to manage this newly uninsured risk. First, make sure that a scientist has reviewed the building design and evaluated the overall design parameters as they relate to water-intrusion risks.

Also, ensure that all the stakeholders are properly insured. This will require a change to the standard loan-covenant insurance requirements, most of which have not been changed to reflect the introduction of universal mold exclusions in 2004.

Universal mold and bacteria exclusions require all stakeholders to pay attention to their insurance needs in this area. Lenders should ask for Agency Company Organization for Research and Development form No. 28, an industry-standard property insurance form, as evidence of commercial property insurance. This form will specifically disclose mold coverage or lack thereof.

Finally, by requiring appropriate insurance, lenders can offload much of their water-intrusion risk-management function onto insurance underwriters who can provide a wealth of loss-control services and oversight to the project.

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Risk management can actually save money on a project. For example, it is well-known that buildings with sprinkler systems pay less for fire insurance than buildings without these systems. In some high-value buildings, the discounts on the fire-insurance premiums over time are even enough to pay for the initial cost of the sprinklers.

The environmental movement creates new opportunities and risks for commercial property-owners and lenders. The most-immediate effect will be seen with green buildings. To participate in this new market opportunity, lenders must develop new underwriting skills and environmental-risk-management protocols.

Brokers who understand the process and advise their clients on obtaining the appropriate coverage will enjoy a competitive advantage in the loan-origination process.


 


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