Returning to our theme that nothing’s easy and everything keeps changing, here is one out of left field. Let’s talk Probable Maximum Loss (“PML”) and seismic risk. ASTM International, the market standard setting organization for everything from toilet bowls to condoms, has just issued an amended seismic standards: Standard Guide for Assessments of Buildings (E2026-16) and their Standard Practice for Probable Maximum Loss Evaluations for Earthquakes (E2557-16) (the “Standards”). These Standards establish an industry norm for the requirements to evaluate the financial risk for real estate in zones with seismic activity. Each investigation of real estate is “graded” between a Level 0 investigation (high uncertainty) and a Level 3 investigation (very low uncertainty) based on the qualifications of the assessors and the work done during the investigation. The Standards refer to a Level 0 investigation as a “desktop” investigation, maybe (in a completely subtle way) to imply something about the proximity of the assessors to the potentially shaking site.
Getting a PML is a regular part of commercial real estate diligence, particularly in those portions of the country that have a history of earthquakes. Check how bad the place is shaking, take a view about the risk, insure what is insurable and if all seems tolerable, then close. Now comes ASTM with a new protocol and we need to pay attention. Probably most of us have never spent a great of time wondering how a seismic assessment is conducted. I, for one, have never read the Standards.
The new standards, however for the first time will impose qualification requirements on senior assessors and field assessors with responsibility for investigating the site and producing a field report. The amendments to the Standards require each field assessor to be a licensed civil or structural engineer, with specific experience requirements including at least two (2) years of seismic risk assessment of buildings. Prior to the amendment, lenders often did not require this of their initial field assessor and neither did the Standards. Now, the problem is that if such field assessor doesn’t meet the qualifications in the Standards, the investigation will automatically be reduced to a Level 0 report. That’s a report that one should consider carefully before relying upon.
Generally, lenders deal with seismic risk either through an internal engineering group or through their insurance consultant (or God help them, through outside counsel), which intakes an engineering report from a third-party vendor and advises as to what and to what extent seismic insurance is needed. Rating agency criteria is either unclear or out of date, or both.
Best practice would be to insure that lenders’ internal seismic guidance picks up these new standards, insure that their engineering vendors meet it and their insurance consultants monitor it.
Standards are a two-edge sword. They’re terrific in that they represent best thinking of hundreds of professionals, about how to go from A to B. That can be super helpful. On the other hand, standards can, particularly those from ASTM which is a widely recognized standard setting service, create a very bright line. In the old days, when I was last doing workouts, I hated lenders’ manuals because borrowers could always pick apart lender performance in comparison to those lending manuals and find things they did wrong. That’s a risk here. Ignore ASTM at your peril. While a lender could ditch the manual, these ASTM standards cannot be avoided. Let’s all be aware that failure to meet the standard is red meat to trial lawyers, regulators and other second guessers within and outside your institution.
So make sure your internal criteria pick up the new Standards and that processes are in place to make sure that the new Standards are embraced. Talk to your engineers and insurance consultants and make sure they are aware of the changes as well. Standards are great in that they can make our lives easier…that is as long as they are met.
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