Eliminating – or at least minimizing insurance risk – is a high priority for loan underwriting. Doing so is part of a successful closing. However, getting there is far from easy. That’s why we have developed a list of guidelines to help get you closer to ensuring your lending is as risk-free as possible. The only thing you must do first is an in-depth review of your borrower’s insurance program. Then you are set up for success.
Guideline 1: Realize Certificates Don’t Equal Insurance – Just because you hold a certificate of insurance doesn’t mean you hold insurance coverage. The broker world is notorious for providing poorly completed insurance certificates, full of countless errors. Some errors are minor and clerical; but many are major and substantive. The major errors have a marked impact on the adequacy and accuracy of the coverage being represented.
While it may be surprising to the uninitiated, the average number of times a broker certificate must be revised is 3.5.
“The average number of times a broker certificate must be revised is 3.5.”
Typically the first certificate pass shows the wrong limits, borrower name, address, or the wrong policy altogether! We have seen cases where the collateral of a loan is represented to be under a blanket policy, when the coverage is actually stand-alone. Simple clerical errors, when not caught, equate to inadequate evidence of coverage. The inconvenient necessity of validating certificate details can make all the difference.
Guideline 2: Read your policies – There is no substitute for reading policies to make sure the coverage for your borrower is adequate, and provides the appropriate limits, terms and conditions shown in the certificates of insurance. Part of the high error rate in certificates is attributable to the fact that the policy wording is not properly represented. Property policies have many exclusions and endorsements that are not accurately identified on the certificates, which materially impacts the coverage. When you full y read the policies described by the certificate, you are likely to uncover a number of issues affecting the coverage limits, terms and conditions.
Guideline 3: Know Your Status – It is a standard practice to provide every lender the status of Mortgagee, Loss Payee and Additional Insured. But are you really getting it? Just because your certificate states a particular status doesn’t mean you have actually been granted it.
Lenders are recognized either by affirmative endorsement to the policy, or as a result of broad form policy wording. The only way to know which is applicable is by carefully reading the policy. While this is an extra step and a time-consuming process, it is essential.
Further, many coverages are broken out on a stand-alone basis; such as terrorism, flood, and earthquake. Since each line of coverage is independent from one another, you must make sure your position is assured on each one. As a lender, your ability to participate, and have a voice, in the claim adjustment and property restoration process is dependent on this point. Claim proceeds only go to the first named insured, and loss payees of record. It is also certainly possible to be a mortgagee, but not a loss payee. The details matter.
Guideline 4: Get Notice of Cancellation (NOC) Sent to You – Many lenders assume that notices of cancellation will automatically be sent to them once they have been granted mortgagee status. Unfortunately, this is incorrect. Many policies are worded such that NOC is only sent to the first named insured. Fortunately, there are simple endorsements that can be issued to resolve this matter. But you won’t know this is the case without either reading the policy, or explicitly asking for evidence that you will receive any NOC.
Guideline 5: Assess Coverage Consistency Between Policies – If there are stand-alone lines of coverage, be sure that business income, terrorism and other covers, such as ordinance or law, are all provided across all stand-alone perils. This is not automatic, and you might be surprised how little coverage is afforded, if at all, as you work your way through these lines of coverage.
For example, Property and business interruption limits may vary substantially between terrorism, quake or flood policies. So, does your property policy include terrorism, and does your terrorism policy include business income? Other questions apply as well, such as:
- Are limits consistent?
- Is Ordinance or Law provided on all lines?
The possible inconsistencies are far-reaching, and much depends on the unique attributes of each property. This is worsened since certificates often lack crucial data about these stand-alone perils, providing only the name of the carrier, policy number, expiration date and property limit.
Guideline 6: Confirm Property Limits are Adequate – In today’s hard market carriers are finally taking steps to assure property values are reported to them at 100% of replacement cost. One method is through issuance of limit of liability endorsements. In short, this means that the value of the claim is limited to the lesser of the blanket limit, or the value shown on the statement of values on file with the carrier. Another way is by putting wording in quotes and binders that premiums are based upon an “accurate reporting of property values at 100% of full replacement cost.” It is critical to know if there are valuation issues, and if policy limit of liability clauses or requirements are in effect.
Guideline 7: Ensure Business Income is Adequate – The insurance industry as a whole has taken big hits by underestimating the potential size of business interruption (BI) claims. This is primarily the result of not understanding the potential for catastrophic claims in general, coupled with not taking into account how long it really takes to rebuild a property after a major loss.
Additionally, costs related to demand surge for labor and materials for regions suffering from catastrophic loses are an enormous blind spot for carrier loss modeling. The de facto standard requirement of 12 months of BI (either rental income or otherwise) is often not enough. See below for further details about “Period of Indemnity” considerations to avoid claims exceeding the available limits of coverage.
Guideline 8: Customize Your Period of Indemnity – This is the length of time over which a carrier will permit a business interruption loss to be presented for payment. If the claim takes longer than the period of indemnity, those extra expenses are excluded. Matching the period of indemnity to a realistic time frame for rebuilding a property is difficult. The scope and complexity of the property largely determines this. Perhaps an industrial warehouse could be rebuilt in 12 months, but a 15 story condo tower might take 24 months, or longer. Other factors you should consider include time to demolish and clear a site, rebuilding of foundations, and permitting and engineering delays. Be conservative and custom tailor your requirements to get the right period of indemnity.
Guideline 9: Tailor Your Extended Period of Indemnity – This applies to the length of time it takes to lease up the property again after repairs have been completed. Again, it can take a lot longer than the industry standard of 12 months. As you consider your unique needs, know you can custom tailor your requirements to match the attributes of your collateral.
Guideline 10: Know Your Concentration Risk – Blanket coverage often provides for a comfortable cushion of additional property coverages. However, this cushion is easily exhausted if there is a concentration of values in a tight geographic area. Many borrowers refuse to provide full details of their portfolio holdings under the guise of confidentiality. But as a lender, it is imperative to know if critical limits are being shared by more than your subject property. There is no way to know if that big blanket limit is really adequate to protect your collateral in a catastrophic loss scenario without knowing about other nearby properties.
Using these fundamental 10 guidelines you should be well on your way to minimizing your loan insurance risk for almost any circumstance. While much of the review process can be time-consuming, it pays for itself many times over. If you are ready for expert assistance on your next loan closing diligence, our team is one of the most respected in the industry. Contact us today.