The implications of the events of September 11 are wide ranging and affect virtually all parts of the insurance market. Hardening of the insurance market was already underway ? particularly after the liquidation of Independent Insurance in June 2001 ? and the fear of terrorism at unprecedented levels of ferocity has accelerated this process. The insurance industry is facing the largest catastrophe loss in history as a result of the US terrorist attacks. Current loss estimates are between $30 billion and $70 billion world-wide although the industry's exposure remains to be finally determined.

The effects on future insurance capacity will only become clear once the 1 January 2002 renewal date for many treaty re-insurances has passed. The insurance marketplace is currently complex and volatile and significant increases in price, restrictions in coverage and reduced overall capacity are forecast.

The impact on reinsurance cover has been significant. In some cases insurers are finding it difficult to reinstate their reinsurance protection or purchase new cover and are limiting their participation to the retention they are able to accept without reinsurance support (their ?net line'). Reinstated reinsurance cover for the last quarter is often costing insurers as much as the original annual contract. In continental Europe, some insurers have issued notice of cancellation on renewals to all insured. In the UK, quotes have been withdrawn and capacity from individual insurers reduced. A number of insurers are currently unwilling to quote terms until their reinsurance arrangements are finalised. The most affected coverage lines are expected to be terrorism cover; property, including business interruption; aviation hull and liability; and workers' compensation.

UK PFI/PPP

Property

2001 had already been a difficult year, with industry losses and the escalation of treaty reinsurance costs. Many insurers have exhausted their reinsurance cover, and will have to reinstate cover at escalating prices. This has caused several insurers to issue a moratorium on writing new business while they attempt to assess the potential effect on their reinsurance.

Terrorism cover continues to be available from Pool Re. (at the time of writing, Pool Re. have made no comment on whether they intend to change their current rating structure).

Individual insurers have had to reduce their level of participation on each risk as they have less reinsurance protection, requiring more insurers to participate to complete risks. Many are no longer willing to quote for the full value of assets insured and fixed loss limits are being imposed. In order to place cover up to the loss limit, it will need to be arranged in layers, which may have cost implications.

Long-term programmes are proving very difficult to obtain. However, to date, Construction All Risks policies are still available for the whole construction period. There are continuing increases in policy deductibles; business interruption deductibles of 60 days are becoming the norm. Premiums are increasing and pressure is being placed on areas of cover where little previous underwriting information is available and where there are concerns, for instance, suppliers' and customers' extensions.

Project finance and financier issues

The rising costs of insurance must be taken into account when planning new projects and in reviewing the business plans of existing projects.

Regarding credit agreements for new projects, the minimum insurance schedule will need to take account of the hardening insurance market. In particular, deductible levels need to reflect the levels insurers are now quoting. For existing projects, the renewal terms that the Borrower obtains are unlikely to comply with the minimum insurance schedule in the Credit Agreement. The Borrower will be seeking to invoke the ?market availability? clauses that most credit agreements contain.

The security rating of insurers needs to be monitored. Insurers exposed to heavy losses from recent events are likely to see their ratings downgraded. This has already happened with some insurers.

With deductibles increasing, the Borrower will be faced with retaining more risk, and with having to fund these increased deductibles from its cash flow. The insurance market is moving to a position where it no longer considers certain risks insurable, e.g. sabotage and terrorism. Alternative methods of risk transfer will need to be considered. The project will need to be reviewed to make sure it is robust enough to pay potential losses and has risk management practices in place to reduce the impact of future losses.

It is becoming increasingly difficult to place insurance cover on a full value basis. In many cases cover will only be available for a maximum any one loss, which will be below the total sum insured for property damage and business interruption. Lenders must be comfortable that the limit for the cover is sufficient to cover the estimated maximum loss at the site.

Airports

Airports, general aviation and other service providers have all been affected by restrictions in coverage. In many cases cover has been limited to damage to property on the ground and to third parties killed or injured on the ground from war, hi-jacking and terrorism. In certain cases, for airports and service providers, insurers have withdrawn cover in full.

Energy

Market capacity has been severely reduced in the energy off-shore risks sector. There will be a rise in deductibles and premiums for construction of off-shore projects. Because of the lengthy policy periods, construction may need to have phased policies e.g. an onshore fabrication phase, a row out phase and an installation phase, all requiring different markets.

Lloyds continues to be one of the top markets writing stand-alone cost control cover. This class of business will continue to experience increases, although it is believed there will be sufficient capacity to cover demand in this area.

In the energy onshore risks category usable capacity has dropped. Rates have risen and various markets are now only quoting with a sabotage and terrorism exclusion. Quotations are being held open for very limited periods. Markets are currently refusing to underwrite or renew business in certain territories e.g. Pakistan, Iran, Libya.

Construction

This is expected to remain one of the toughest classes of business. The dramatic rise in deductibles and premiums will continue at a steeper level, particularly if capacity is further restricted arising from concerns with insurer security. Cover is likely to become more influenced by re-insurer wordings and requirements.

Third-party liability

The primary market was already experiencing significant increases in price, restrictions in cover and increases in deductibles, prior to September 11. Placing $50 million lead policies will be difficult, and $25 million will become more commonplace. Increases in deductible levels are also being seen, though these remain modest when compared to Property Damage and Business Interruption.

The disaster has also highlighted the possibility of an event involving multiple insurers occurring in ways previously not foreseen as realistic. All of these circumstances are creating a more conservative underwriting environment.

Oil and gas

For onshore projects, pending renewal of the reinsurance Catastrophe Treaties in 2002, a substantial number of renewal quotations are being given on the basis that Catastrophe Perils are excluded or permitted only with low sub-limits.

Sabotage and terrorism cover is either unavailable or subject to restricted limits. Where cover is provided a loss limit will be imposed, which will be well below the total sum insured and be combined for property damage and business interruption losses. Many insurers are seeking a right to review their participation as at 1 January, 2002 dependent on insurers' reinsurance treaty renewal negotiations. The entry of the general non-marine market into energy is anticipated at higher deductibles and rates than those seen since the 1980s.

For offshore projects, pending placement of reinsurance programmes for the year 2002, many underwriters are uncertain as to what coverage will be available at economically viable prices. Accordingly, underwriters are very cautious as regards line size. This is having a major impact on all classes of business, especially offshore construction risks.

Political risk

For current policies, most political risk cover is provided on a non-cancelable basis. Insurers are not able to change the terms of the policy or cancel the cover if political circumstances in a country or region deteriorate.

For new policies and policies coming up to renewal, there will be an impact on the cover that is available depending on the countries involved. Cover for countries in the Middle East and Central Asia will become harder to obtain and will be considered on a case by case basis.

Premiums for political risks cover will continue to increase. With the property insurance market looking to limit or exclude terrorism cover, the political risks insurance market may provide an alternative source of cover.

Shorter-term policies are likely to be offered; typical periods will be three to seven years. Capacity in the insurance market will fall. In the past cover up to $1 billion per risk had been available. This is likely to fall to $500 million per risk. Any premium indications that insurers provide will be on a non-binding basis and insurers will have the right to amend the terms quoted until the cover is bound. Once bound, the premium is set for the full policy term.

Impact on project concession agreements

Many international projects have, for political risk, been protected through ECA cover and/or the participation of IFC and other multilaterals. Accordingly, one would not expect the changes to the insurance market to affect political risk coverage.

For existing signed deals, an increased cost burden for sponsors can be anticipated. Generally, project concession agreements require the project company to take out specified insurance and compliance with such an obligation will be more costly. The UK Treasury Guidance emphasises this point, remarking that increased cost of insurance is a matter for the project company.

While ?market availability? clauses (i.e. clauses which allow risk not to be insured where the relevant insurance is not available or is prohibitively expensive) have become more common in project loan agreements, the scope of these clauses is generally narrow and would not be expected to provide much relief to hard-pressed project sponsors.

It will be a matter of commercial judgement whether project sponsors are ready to argue that particular risks are uninsurable on the grounds of market unavailability. Such claims are more likely where a dispute as to availability of insurance is submitted for determination by an insurance expert as opposed to regular dispute procedures, but the cost of any dispute resolution process will have to be weighed against the increase in premium.

Moreover, as many current project sponsors will probably be contemplating selling on at least part of their participation in projects at some stage, recent events may only affect the price at which existing project sponsors sell out.

An interesting point with regard to PPP projects is to what extent authorities will be tempted to push the concept that a premium increase is a risk entirely for the project sponsor. Whilst the Guidance puts this risk on the sponsors, it might be said that taken to its logical limit, the principle would make the sharing of the benefits of re-financing less profitable for the Authority if the re-financiers were to price in an element to cover extra costs such as higher premiums.

It is difficult to predict a consistent approach to insurance arrangements for deals yet to be signed. It is safe to assume that the interests of project sponsors, project lenders and concession-granters are broadly aligned in that they all want the project assets to be insured. One would expect new deals to be priced with this consideration in mind. To cater for any future softening of the market, a variant of UK PPP benchmarking might be used or the point could be left for the future; current competitive bidding may well indicate the trend here.

Negotiations concerning insurance have normally not been about adequate insurance of the project assets, but about second-level issues such as the level of deductibles, non-vitiation clauses in favour of the lenders, limits of business interruption cover etc. On these issues, while the concession-granter and -holder might have some common ground in wanting to keep costs down, the lenders will probably insist that any lowering of coverage on such points is compensated for by more sponsor support or more costly project reserve accounts.

Absent specific types of project for which insurance may for a while not be available, the most likely consequence of recent events will be a short-term cost or loss of profit to the project sponsor and a possible impact on the medium term value of the project. Quite possibly, in the longer term recent events will confirm the ability of the insurance market to weather short-term problems.

The authors gratefully acknowledge the contribution of Martin Benatar of Marsh Bankkriusk.ble fixture for similar transactions in an increasingly active market.