Indemnity Insurance and Commercial Real Estate: Panacea or Snake Oil?
At a recent gathering to wave a former colleague off into retirement, I found myself in conversation with another who now specialises in indemnity insurance for the property sector. What began as a lightweight chat about the stress-relieving virtues of such products in residential conveyancing, turned into a thought-bending analysis of how insurance might be a solution to most, if not all of the risks inherent in commercial real estate (CRE). Strong claims you might think, but title insurance is not new and has been a feature of the US market for some time. The UK has tended to use the product more sparingly: in the residential context, but also in larger 'portfolio' transactions where full title investigation/DD is often impractical, disproportionate and costly.
As retirement talk returned to nostalgia, and deals gone by, I started to wonder if the UK CRE market is similarly rooted to the past, the world moving on without it. Are the brokers and insurers on to something, or are we right to be more cautious in our take up of the product?
Insurance is broadly available to all players in the sector: owners, operators, developers, investors, and lenders, and for all types and stages of transactions. Products promise to protect investment and maximise returns; they can provide "security" for lenders, improving their customers' chances of obtaining funding or renegotiating terms. Much like TV commercials for the full range of domestic insurance, advertising materials boast that policies can be put in place within days and you can sit back, safe in the knowledge you're covered.
It's fair to say that, despite a comprehensive land title registration system, the UK still has its fair share of legal idiosyncrasies and real estate complexity. Regardless of the scope of due diligence there will always be known and unknown risks, particularly in relation to the ownership, use and occupation of CRE. However, where once seen as a defective title solution, indemnity insurance has expanded to the point that brokers are confident they can arrange cover for nearly every risk on a transaction, for a price.
Insurable risks
The focus of most brokers remains on title and typical risks identified in DD, such as:
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Access issues.
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Restrictive covenants.
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Interference.
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Rights of light.
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Third party rights.
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Lack of searches.
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Missing documents or information.
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Insolvency risk (e.g. transactions at an undervalue).
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Judicial review (e.g. planning, breach of procurement rules).
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Other defects of title.
However cover may also be available for more unusual risks, such as unexploded ordnance, or fraud and ground rent portfolios might be insured, for example, where a seller is unable to produce receipts.
Extent of cover
Insurance will typically cover specified losses (up to a limit) for the insured parties, who may include mortgagees. Consequential losses (delays, business interruption, loss of rent etc.) might also be included.
On portfolio transactions for example, large swathes of the asset base might be covered by insurance, leaving the trophy properties the subject of more focused attention from the lawyers.
What advantages does indemnity insurance offer?
Is insurance just a substitute for better DD, or a plug-and-play solution when time is short? Brokers and insurers will (naturally) argue it is more than those. For example:
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Policies demonstrate versatility. They can be tailored for specific scenarios and written in favour of various parties.
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Cover may be provided for any term, including in perpetuity to future owners/lenders (e.g. covering residual liabilities even if the property is sold) or made transferrable.
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By resolving ownership issues, indemnity insurance can assist in a clean exit, leaving contingent liabilities with the insurer.
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DD is invariably limited and, at some point, reliance will be placed on a professional adviser's PI cover. Insurance simplifies large and granular portfolio deals (typically by sampling) and reduces transaction DD costs.
Separately recent cases have demonstrated that recoveries against valuers' and project monitors' PI cover are falling short. Limitations in the amounts recoverable and the circumstances where claims are successful might indicate that there need to be other avenues for recovery. The Global Financial Crisis starkly demonstrated that asset-based security and guarantees are inherently susceptible to market fluctuations.
Funders and borrowers are already used to insuring against risks in other ways. Insurance is obviously an existing feature of CRE transactions (buildings, construction risk etc.). Hedging arrangements and security (collateral) are other ways that parties seek to manage risk. Perhaps comprehensive indemnity insurance protection is just an extension of that.
Costs and claims
Premiums are paid up front and standard cover can be found for a low percentage of the insured amount. Anecdotal evidence, and current pricing, suggests that claim rates are low. Whether that remains the case through the next business cycle remains to be seen.
Final thoughts
There is no doubt that, provided cover on the right terms is available - and for the right price - indemnity insurance has the potential to provide a single, streamlined solution for complex acquisition and development CRE transactions. But while the coffee shops of Gracechurch St, Leadenhall and St Mary Axe perhaps aren't full of Snake Oil salesmen, neither should we regard them as purveyors of panacea.
The key is to identify the risks (insurable or otherwise) first. Also insurance won't cover a bad bargain, or remedy the underlying defect. If the deal isn't right to begin with - that is it doesn't work on a commercial level - it is unlikely that indemnity insurance will be much use in that context.
Insurance may also be invalidated. For example, where an owner subsequently seeks to formalise a lack of access that has been insured or where a local authority is made aware of a lack of consent that was covered on a policy.
And what about the fear that insurers might just be doing lawyers out of a job? Perhaps what indemnity insurance might actually achieve is to take the heat out of a transaction, allowing all the professional advisers to focus on getting the best commercial agreement, adding real value to their clients. And isn’t that what we all want?