Foreclosing lenders face various risks and risk-financing options as commercial property owners halt partially completed projects because of the weak economy, insurance experts say.

While financial institution insurance does not cover those risks, lenders can salvage the defaulting owners' commercial construction coverage or turn to the surplus lines market, experts said.

During the second quarter of 2009, 1,233 office, retail and industrial projects were deferred or abandoned, said Abigail Marks, a Boston-based economist with real estate consultant CB Richard Ellis Inc. That's down slightly from 1,305 projects during the first quarter but 83.8% greater than the 671 projects that were deferred or stalled at year-end 2006, CBRE's figures show.

Indeed, construction stalls have hit a 30-year high, noted Jim Haughey, the Boston-based chief economist for construction industry analyst Reed Construction Data.

The driver is falling commercial property values. Decreases vary by region, but range from 30% to 40% and exceed 50% in highly distressed areas, estimated Stephen Cumbie, a professor at the University of North Carolina's Kenan-Flagler Business School in Chapel Hill, N.C.

Falling property values can make the owner's construction loan-to-property-value ratio soar, often compelling a lender to stop funding its loan.

Falling rental pricing and demand have exacerbated the problem, prompting project owners to voluntarily halt construction, experts noted.

As a result, whether a lender is a bank or an institutional investor, it faces “a real paradigm shift,” said George Dale, an executive vp in the construction services group at Aon Risk Services Inc. in Los Angeles.

“In the old days, banks that foreclosed sold the property to another developer and would make OK money,” Mr. Dale said. “Now, banks are seriously considering going into the land development business.”

When a lender quickly sells a foreclosed project, the buyer assumes the builder's risk and completed operations risk, said Joe Savarese, vp-casualty risk in Tinton Falls, N.J., for surplus lines insurer American Safety Insurance Services Inc.

But if the lender keeps the property until a buyer appears or economic conditions warrant finishing it, then the lender has a property risk and a premises liability risk, experts said.

If the lender completes and sells the project, then the lender also assumes construction-related and completed-operations liability risks, Mr. Savarese said.

Contractors involved in the project also would be liable for any construction defects, although identifying the contractor at fault after a lender brings in new contractors can be difficult, an expert said.

Regardless, “everyone gets sued” if there is a defect, Mr. Savarese said.

Because a lender would have established insurance requirements under its original loan agreement, it has “a great interest” in keeping the existing coverage in force, said Colin Daigle, the Washington-based global construction consulting practice leader for Marsh Risk Consulting. The lender either could assume responsibility for the coverage or work with the project owner or contractors to maintain the coverage, he said.

When an owner-controlled insurance program—a wrap-up liability policy covering the owner and most contractors—is involved, insurers “are open” to transferring the coverage to the lender, said James Conroy, a vp and the chief underwriting officer for national market construction at Boston-based Liberty Mutual Insurance Co.

However, the original contractors would have to “stay in place,” he said.

But, Mr. Savarese noted, transferring a policy would not be possible if the lender had not been an additional named insured on the policy, when the insurer has canceled the policy for nonpayment, or when the original project completion date has passed.

The original OCIP insurer also could cancel coverage if the lender changes the design substantially to minimize completion costs, Mr. Conroy said.

When the original OCIP cannot be tapped, arranging a contactor-controlled insurance program for the original contractors is not a strong option because their general liability policies probably would contain wrap-up exclusions, Mr. Conroy said.

But finding replacement liability coverage is relatively easy if the project is not stalled longer than 60 to 90 days, said Ronda Whaley, a senior vp for wholesale broker Brown & Riding Insurance Services Inc. in Los Angeles.

“The surplus lines market will step in,” she said.

Ms. Whaley said builder's risk insurers are “quite competitive,” because new construction is minimal. If a project is halted only temporarily, coverage typically can be placed within 24 hours at nearly the same cost as the expired coverage, she said. But coverage for indefinitely stalled projects is more costly and restrictive, she noted.

Among surplus lines insurers offering coverage for foreclosed commercial properties is American Safety Insurance Services Inc. Foreclosing lenders can purchase general liability coverage that provides premises liability and extended completed operations coverage, Mr. Savarese said.

Boston-based Lexington Insurance Co. writes coverage for stalled commercial projects, said Tom Grandmaison, a senior vp and head of the construction practice.

Lexington's idle-asset policy provides liability coverage for indefinitely stalled projects; the insurer also can provide property coverage for facilities stalled at any stage of construction. Lexington also might offer liability cover for future operations on a project-specific or wrap-up basis. In addition, it writes discontinued operations coverage for the completed work of contractors that have been acquired or taken over via foreclosure.

Ironshore Inc. offers nonadmitted general liability cover of stalled projects at any stage through its Boston-based IronBuilt unit, said Joe George, president of the division.

He cautioned insurance buyers to carefully evaluate insurance options, because “there is a lot of misunderstanding—a lot of miscommunication in this marketplace” involving the breadth of coverage for past, present and future claims. “Buyers should be extremely diligent in knowing what is covered,” he said.