In order to secure a loan claim in real estate financing, the financing bank is regularly furnished with a land charge on the property in question. A building insurance policy is signed by the borrower in order to retain the intrinsic value of the lien. However, concluding an insurance policy alone does not guarantee comprehensive cover for the financing bank. Additional agreements must be concluded between the bank, the client and the insurer.
Building insurance does not provide security for a loan in the narrower sense. As building insurance secures the intrinsic value of the security for a loan itself (generally speaking the real estate secured by a land charge), it can be called an indirect security or figuratively speaking a safety net for the real estate financier.
The insurance claim as collateral
Entitlement to an insurance benefit is a contingent and thus uncertain claim which lies in the future. If it should come into effect, the financed building would be destroyed (in the most extreme case) and the land charge would be rendered worthless as a result. Thus, banks must secure the insurer’s future promise to perform as a surrogate for their own collateral.
Registering liens and insurance guarantee certificates
First, the bank can improve its legal position by formally registering the lien with the insurer: When doing so, special statutory protective provisions apply in favour of the bank (sections 142–149 of the German Insurance Contract Act (Versicherungsvertragsgesetz - VVG), which ultimately ensure that insurance coverage does not lapse if e.g. an insurance premium has not been paid by the client. In addition, the client requires approval from the bank to terminate the insurance relationship.
This protection, however, applies exclusively to insurance against fire and is not applicable to storm, mains water, burglary or similar damage, which is often included in the insurance coverage. The bank should therefore arrange cover for risks other than fire by concluding insurance policies to this effect. In this respect, the insurer generally issues insurance guarantee certificates for the bank. Banks should ensure that the protection specified in the insurance guarantee certificate corresponds to all insured risks and to the statutory provisions for fire insurance.
Influence on the payment of insurance benefit
In order to have some control over the payment of insurance benefits, in some cases a so-called loss payee clause is included in the insurance policy according to which the insurer may only issue a payment after gaining the bank’s approval. The bank does not however acquire its own claim to insurance benefits as a result. Ultimately, it is thus very doubtful whether this form of protection is secured against insolvency. It would be preferable, on the other hand, to assign the claims.
Insurance for the benefit of third parties
As the financed real estate is of interest to both the insurer as owner as well as to the policyholder, banks will be involved in the insurance relationship as an insured third party owing to insurance guarantee certificates (insurance for the benefit of third parties). The insurance policy in this case is only concluded between the client (policyholder) and the insurer. However, the co-insured bank has a claim against the insurer which the bank can assert according to the VVG and usual market insurance policy conditions, but not without the approval of the client. In addition, the client may dispose of this claim and for instance assign it to a third party (sections 44–45 of the VVG). This option is thus relatively complex without there being strong advantages compared with assigning insurance claims.
Assignment of the claim to insurance benefits
In order to ensure their protection is complete, banks can ultimately have the client’s (future and contingent) claim to insurance benefits assigned. Contractual bans on assignments – e.g. in the general conditions of the insurance policy – do not prevent assignment in the commercial sector pursuant to section 354a of the German Commercial Code (Handelsgesetzbuch - HGB). If the insurer is notified of assignment, the insurer can no longer provide the client with this service with debt-discharging effect (section 407 (1) of the German Civil Code (Bürgerliches Gesetzbuch - BGB).
Banks can obtain wide-reaching protection of their security interest if they:
- register their liens with a building insurer
- have an insurance guarantee certificate issued by the insurer which includes provisions for fire insurance pursuant to sections 142–149 of the VVG
- have all future client claims to insurance benefits assigned to them and notify the insurer of the assignment.