The recent flooding rains in Texas are a vivid reminder that catastrophe losses can arise without warning. And if the pictures of flooding on the Blanco River aren’t enough to make lenders queasy, hurricane season officially began on June 1. So the question for lenders and servicers is simple and stark: do my borrowers have sufficient insurance to protect the property that is collateral for their loan? Here are some reminders of perennial insurance issues, all of which should be checked regularly by lenders and servicers. Think of them as the lender/servicer equivalent of changing smoke detector batteries on New Year’s Day. Lenders should ask themselves the following:
What proof of insurance do I have? Too often the “proof” of insurance provided by a borrower consists of an ACORD 28 form. That form states that it is evidence of insurance, but if it is on the version issued after 2006 (highly probable), it also contains disclaimers stating that the form is “for information only” and that it confers no rights on the holder. Such forms mean what they say, so lenders should ask for more—up to and including copies of the policy itself.
How am I named on the policy? If the lender is named as the “loss payee” on a policy of property insurance, it has very few rights. The insurer may ultimately issue a check made out to both borrower and lender (this doesn’t always happen—read ViewPoint Bank v. Allied Prop. & Cas. Ins. Co. 439 S.W.3d 626 (Tex. App. – Dallas 2014, writ denied) for an example of what can happen), but the borrower still controls when to settle a claim and may well abscond with the check. Lenders must be specifically named as a “mortgagee” or “lender loss payee” to have protection; being named on an ACORD 28 is not enough. This can get extremely complex when the borrower has loans on the building with one lender and on fixtures and equipment with another; but you should still be a “lender loss payee.”
Is there flood insurance? For banks, this is a highly important regulatory question that must be answered in very specific ways to avoid imposition of civil money penalties. For non-bank lenders, having access to NFIP flood insurance may mean the difference between loss of collateral and a loan marked “paid.” Beware—private property policies often indicate that they provide coverage, but it can be for a separate and very small sublimit. For all lenders, having flood insurance is essential.
Is there terrorism coverage? There have been a lot of issues in Texas recently stemming from Congress’ failure to reenact TRIA at the end of 2014. That aside, the recent shootings in suburban Dallas are a reminder that it can still happen. What is your policy on terrorism coverage?
Is there a blanket policy? Many borrowers, in good faith, provide insurance on property used as collateral via a blanket policy—a policy that provides coverage for many different locations. Some blanket policies have aggregate limits so that if there is a loss or losses at two locations, there may not be sufficient limits to fully pay for both. This is not far-fetched: after hurricanes Katrina and Rita, blanket policy issues came up frequently.
Coinsurance/Valuation? Coinsurance is a penalty for undervaluing the insured property. It becomes a problem when property values go up but policy limits are kept at an older, lower level. Have you required your borrowers to increase limits at renewals in order to prevent imposition of a coinsurance penalty?
Do renewals meet loan requirements? Problems with insurance are more likely to arise at policy renewals, which are more frequent because policy terms are now shorter. Lenders check insurance carefully at loan inception, but lenders and servicers may not do so after the money has changed hands. Sadly, insurance is an area where borrowers can be tempted to scrimp; insurance costs money, which decreases the bottom line. Paying attention to insurance issues is just as important in year 10 of a loan as it is at day one.
The bottom line here is that insurance is not a file-and-forget part of a loan file. It needs attention on a regular basis, and often from trained professionals, to protect lenders and servicers from loss of collateral. Did I mention that hurricane season began June 1? What insurance do your borrowers have?