Art Collectors Beware of Uncovered Risks

August 2012Art & Advocacy, Volume 12

In the Winter 2012 issue of Art & Advocacy, the article “Managing the Risks of Art Ownership with Insurance” provided an overview of basic considerations that should be taken into account when insuring artworks. That article noted that while most fine art insurance is termed “all risk coverage,” it does not actually cover all risks because (1) there are particular losses that do not result from physical damage, and (2) policies typically contain exclusions for certain kinds of damage. This article will look at some of those exclusions and other potential risks of which owners of fine art should be aware.

Standard fine art insurance policies focus on losses caused by physical damage to artwork, which means that some significant risks may require separate coverage or are simply not covered at all. Chief among these are issues regarding good title and authenticity.

One of the most basic questions about works of fine art is whether the purchaser actually acquired good title. In the vast majority of transactions, this is not an issue: Good title typically transfers to the purchaser in the ordinary course of a transaction. Problems arise when a collector unknowingly acquires a piece that has previously been stolen or when other issues impair the purported owner’s ability to transfer clear title. In the case of stolen artwork, under general principles of common law in the United States, a thief cannot pass good title, so no one further down the chain of ownership—not even a good-faith purchaser for value—will have a better right to the property than the original owner. Absent a valid defense, such as the expiration of the statute of limitations on the original owner’s claims, a purchaser can be forced to surrender an artwork that was previously stolen.

In such a case, a collector may look to the seller to recover the purchase price, but recovery may not be possible if, for example, a dealer has subsequently gone out of business or the statute of limitations on the purchaser’s claim has expired. In the worst case, a good-faith purchaser can find himself without both the artwork and the money he paid for it. A careful collector will look for ways to reduce this risk. The first is to diligently examine the provenance of an artwork before an acquisition. This process can identify potential risks, such as a gap in provenance during the Nazi era, so that the collector can evaluate them. If provenance or other issues cannot be resolved, one possible solution is title insurance. Title insurance has long been available for real property, but only recently became available for fine art and other important collectibles. According to Judith Pearson of ARIS Title Insurance Corporation, “the art market has changed substantially in the last decade and there has been a corresponding increase in title disputes. Collectors who undertake good due diligence often can reduce the title risk, but, because the art market is not transparent, cannot eliminate it altogether. Potential title challenges facing today’s buyers in most cases will persist until the buyer-collector or their heirs decide to sell or transfer a work. Title insurance shifts this indefinite risk to protect collectors’ art assets.”

Another area of concern is the authenticity of an artwork. Just as insurers will not generally cover losses due to lack of title, they also will not pay for a loss in value stemming from the reattribution of an artwork or from a determination that an artwork is an outright forgery. Carefully checking the provenance of an artwork and consulting with experts prior to an acquisition can help reduce this risk, but authenticity is ultimately an inherent part of the art market that collectors must come to terms with.

Caring for art collections, particularly larger collections, requires a certain amount of ongoing administrative work. Although tedious, it can be critical. Jonathan Crystal of insurance broker Frank Crystal & Company says, “there is no insurance against bad administration.” Simple mistakes can lead to large problems down the road. For example, a collector whose fine art insurance includes a schedule listing the insured items in his collection might forget to add a new acquisition, or a piece might be left off the schedule by accident. In the case of a new acquisition, there is often automatic coverage for some period of time after the purchase even if the item has not been placed on the schedule, but after that grace period expires, there could be no coverage for it. If a collector has many works spread over multiple residences, an inadvertent omission may be all too easy. Insuring under a blanket policy (as opposed to a scheduled policy) can protect against some of these problems, but depending on the collection, that might not be the least expensive or best approach. A consultation with an insurance broker experienced in the art insurance field can help a collector make an informed decision about the appropriate type of insurance or understand the terms of the coverage that is already in place.

Making sure that a collection is properly valued is as important as ensuring that the individual works are correctly listed. Having correct valuations is both a short- and long-term issue. Crystal cites contemporary art and Chinese antiquities as examples of fast-moving markets that a collector may need to watch carefully even in the short term. In the current climate, values might increase rapidly over a period of months, potentially leaving an inattentive collector underinsured. Similar problems can arise in more staid markets, although increases in value may take years to accrue. Crystal further warns that, “although they may give collectors some comfort, relying on the protections of the ‘market appreciation’ provisions that are found in many policies can be a mistake.” Under these provisions, with certain limitations, insurers may agree to pay up to 150% of the listed value of a work to account for changes in the market. Here again, however, a dramatic increase in value can, over time, leave the collector underinsured. Regardless of the type of works in his collection, it is important for the collector to make sure that valuations are made on the basis of appraisals by qualified appraisers and that those valuation are regularly monitored.

“Loans of artworks for exhibitions—whether at museums or private galleries—are one area where both borrowers and lenders can get into trouble,” says Steven Pincus, managing director of Dewitt Stern in New York. Where a loan agreement provides that the borrower’s insurance will cover an artwork while it is on loan, both parties should carefully review their respective insurance coverage. Loan agreements often make only general references to the borrower’s insurance without including details. Consequently, lenders need to be sure that they understand the exclusions and limits on the borrower’s coverage. At the same time, borrowers need to be sure that insurance terms that were agreed to when negotiating with lenders are congruent with the underlying terms of their policy. A borrower that enters into a loan agreement promising coverage to the lender that is beyond the limits of its policy may find itself liable for damage that is not covered under its policy. A lender that accepts guarantees that are beyond the limits of the borrower’s policy would have to rely on the borrower’s, instead of the insurance company’s, ability to pay in the event of a loss.

Pincus notes that, “coverage for terrorism is one place where a collector’s policy and the coverage offered by a borrowing institution or gallery might differ significantly.” An individual’s “all risk” policy will typically not exclude damage caused by a terrorist act, but terrorism coverage is not automatically included as part of insurance policies for museums and art dealers. A museum or gallery that wants terrorism coverage must purchase it separately. In 2002, following the terrorist attacks of September 2001, the Federal Government created the Terrorism Risk Insurance Act (“TRIA”), which is essentially a risk-sharing partnership between the Federal Government and the insurance industry regarding terrorist attacks. The law has been twice extended, most recently by the Terrorism Risk Insurance Program Reauthorization Act (“TRIPRA”) of 2007, which extended the law to 2014. TRIPRA is a complex law, containing many restrictions and exclusions that should be discussed with an insurance professional when it may be applicable. Even with TRIPRA, coverage may not always be available at reasonable rates, particularly in areas where there is an unusually high concentration of risk. This may include, for example, certain areas of Manhattan.

Although terrorism may be covered under an individual’s fine art insurance policy, “all risk” policies typically list exclusions for damage caused by other specific risks. Standard exclusions include damage during conservation/restoration work, and damage caused by ordinary wear and tear, gradual deterioration, moths and vermin, acts of war, or radioactivity. The exclusion for damage during conservation/restoration work warrants particular attention. A good conservator will be well trained and exceedingly careful, but as a practical matter, any time that work is being done on an art object, the risk of damage is increased. Nonetheless, many independent conservators have no professional liability insurance because it is prohibitively expensive. Eryl Wentworth, executive director of the American Institute for Conservation of Historic and Artistic Works, describes this, along with related issues, including contractual protections, as a “major area of concern in the field.”

Paul Messier, a Boston conservator specializing in the treatment of photographs and former board member of the Institute, explains that conservators will often disclaim liability for damage during conservation in their contracts, leaving the risk with the owners. Messier views this as a practical consideration: “Museums do not hold their conservators liable for damaging a work of art, and independent conservators need to have the same standard applied so that they are not constantly exposed to potential losses if a treatment goes wrong. Limitation of liability is the foundation of any conservator’s practice.” For the collector, the combination of the exclusion in the insurance policy and the conservator’s desire to limit liability leave open the possibility that there may be no insurance at all for their artwork at a moment of heightened risk. Collectors should have their insurance policies reviewed by an insurance broker and should consult with an attorney about contracts with conservators prior to any conservation/restoration work.

A good fine art insurance policy is the basic protection that all collectors need. But even after coverage is in place, careful monitoring—both of the policy and the collection it covers—is required. Managing risk should be high on the list of any collector’s concerns, and effective risk management may require consultations with insurance brokers, appraisers, attorneys, and others.