Covid-19: Property industry and insurers must grapple with pandemic risk

Covid-19 has meant shuttering multiple business premises across the State. Yet tenants must continue to pay their rent and landlords must continue to service their borrowings. Real estate lawyers in common law jurisdictions have quickly reached a broad consensus around the legal realities of this situation.

First, tenants are unlikely to be able to walk away from their lease obligations. Most leases have no “force majeure” provisions and the shutdown is unlikely to amount to “frustration” (a view supported by a Hong Kong case arising from the 2002 Sars [Severe acute respiratory syndrome] outbreak). Second, landlords and tenants will find that the standard definition of “insured risks” for buildings insurance is of no assistance. Policies are typically concerned only with losses arising from physical damage and so even “loss of rent” cover is of no use.

The new reality begs the question as to how pandemic risk might be best allocated in the future. It is hard to see insurers, banks, landlords and tenants easily agreeing to alterations of current arrangements on a case-by-case basis, without some other shift or intervention. But there is a precedent for the property and insurance industries coming together to resolve risk and cover issues in commercial leases.

The provisional IRA bombing campaign of the 1990s was marked by huge explosions in United Kingdom commercial centres with the Baltic Exchange blast in 1992 alone causing more than £750 million of damage. UK insurers withdrew “terrorism” as an insurable risk. Under a commercial lease, the default position is that tenants are liable for keeping their premises in good repair, including rebuilding. If there is damage by a normal insured risk such as fire, then rent is suspended and the landlord claims under its policy and rebuilds. But damage by terrorism would now be an “uninsured risk”.

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So any future terrorist damage to a building would see tenants under a continuing obligation to pay rent and they could even be liable to rebuild. Should the tenant become insolvent, the risk would fall back on the landlord, with no insurance payout. Property owners and occupiers were worried and there was enormous uncertainty.

In response, real estate lawyers devised sophisticated lease clauses to govern terrorism risk as uninsured or uninsurable. The most usual end point with these clauses sees tenants relieved of rebuild obligations and landlords given an option not to rebuild at all and terminate the lease, or elect to rebuild and keep the lease in place. Rent suspension might or might not apply during the rebuilding.

The UK government decided in 1993 that non-availability of terrorism cover was an unacceptable competitive disadvantage for the UK’s business community and so it intervened and sponsored Pool Re. This scheme allows commercial insurers to pay into a wider reinsurance pool to cover terrorism, capping payouts, with the comfort of having the UK government as the “insurer of last resort”. Expanded since 9/11 and the advent of cyberterrorism, Pool Re today has a fund of some £6.6 billion covering £2.2 trillion of assets. Perhaps mindful of criticism of business interruption cover not paying out currently, there are already UK industry moves to consider setting up a Pandemic Re scheme.

The need for business certainty may force individual countries (and the EU) to look further at reinsurance and back-stop measures. We may be immersed in the immediacy of the current pandemic, but the property and insurance industries need to grapple with this category of risk quickly and decide where the risk should sit for new transactions. Our decisions will be a function of available cover, commercial negotiation and, perhaps, innovative reinsurance solutions.

• Shane Fahy is a partner and head of real estate at McCann FitzGerald