An interesting case crossed our desk last week from the Texas Court of Appeals. The amount at issue, $4,410.69, belies its significance. In Alvarado v. Lexington Insurance Company, Nos. 01-10-00740-CV, 01-10-01150-CV, slip op. (Tex. Ct. App. 1st Dist. Apr. 19, 2012) (attached), the court thoroughly examined (with extensive citations) the issue of whether a homeowner, subject to "force placed" insurance, has any rights in the policy obtained by his lender. The majority concluded that the terms of the policy established that the homeowner was an intended beneficiary and could claim under the policy. The dissent strongly disagreed (attached).
This issue is likely to have increasing prominence for lenders (and their insurers) as the correspondence between the mapped flood plain and reality becomes more and more in error. See Underwater? What Climate Change Means for a Loan Portfolio Near the Flood Plain, Massachusetts Banker (2011). The proposition is fairly simple. As a result of climate change, storms in many areas will become more frequent and more severe. The effect of this is to make the current 100-year flood plain an under-estimation of the actual area at risk for a 100-year flood. When the Federal Emergency Management Agency (FEMA) or the Army Corps of Engineers finally gets around to preparing accurate flood plain maps, scores of homeowners will find themselves waking up one morning subject to requirements for flood insurance. See 42 U.S.C. § 4012a(e)(1).
Their lenders may do more than just wake up. Pursuant to federal National Flood Insurance Program (NFIP) requirements, they may send letters advising their borrowers of the requirement to obtain flood insurance. Id. Some will comply. Some will not. For those choosing not to comply, the lenders will buy the insurance for them and bill their borrowers back. See 42 U.S.C. § 4012a(e)(2). Even where NFIP requirements do not apply, lenders may still have the right to place coverage for their borrowers as a result of breach of covenants agreed to by those borrowers.
This is force placed insurance. It is defined by one internet source as: "The insurance that a lien holder places on a property, to provide coverage in the event the borrower allows coverage to lapse. Forced place [sic] insurance is intended to ensure that the property remains insured, protecting both the homeowner and the lien holder. The costs associated with forced place insurance are paid upfront by the lien holder, but added to the balance of the lien." A borrower will covenant to insure the mortgaged property adequately. When the borrower breaches (either by not purchasing required insurance, cancelling insurance or allowing insurance to lapse, or failing to procure the right type and amount of insurance), the lender may force place the required policy(ies). All manners of property coverage may be purchased; liability coverage is typically restricted to only general liability. A detailed discussion of the subject was prepared by the Mortgage Bankers Association in 2006.
In Alvarado, the carrier issuing the force placed policy argued the subject policy was clear about
who was named as insured: the lender (and not the borrower),
whose interest was protected: the lender (and not the borrower), and
to whom loss was payable: the lender (and not the borrower).
The borrower disagreed and pointed to Endorsement 12, "Special Broad Form Homeowners Coverage," which provided coverage to "You and residents of your household," defined the insured property as the "residence premises" (the "one family dwelling where you reside"), and provided coverage for living expenses and personal liability. None of these could apply to a bank.
The majority concluded that the endorsement clearly established that the borrower was an intended beneficiary of the contract. "All of these provisions of this endorsement are meaningful only if the "Insured" and "you" referenced in the Definitions and Property Coverages of Endorsement #12 mean the homeowner of an owner-occupied property reported by Flagstaff [the lender] to Lexington [the insurer] on Lexington's reporting forms as having force placed Homeowners Coverage and if the Homeowners Coverage part of the Policy is interpreted as directly insuring the homeowner against loss to property, both real and personal, as well as insuring him against personal liability and certain other personal losses, such as loss of use of the property and additional living expenses." Alvarado at 35-36. "We conclude ... that the additional coverage in Endorsement #12 for which the homeowner is forced to pay additional premiums "ha[s] no purpose whatever" and is meaningless unless the "Special Broad Form Homeowners Coverage" was intended by Lexington, the insurer of the property, and Flagstaff, the mortgagee, to directly benefit the mortgagors and homeowners of the properties specifically described ... on Lexington's reporting forms, including Alvarado." Id. at 41. Coverage practitioners will recognize the majority's decision as a simple application of one of the basic rules of coverage: contra proferentem - the policy will be construed against the one who drafted it.
The dissent rejected all that: "The borrower nonetheless is not a third-party beneficiary to [the force placed policy]: he is neither named as an additional insured nor expressly contemplated to be a beneficiary under it, as defined by its terms—most particularly, its liability limits. To rely on provisions that provide homeowner-types of coverage to conclude that the borrower is insured for these homeowner risks would provide more insurance coverage to the borrower than it does to the named-insured lender, whose coverage is limited to losses in which the lender has "a mortgage or ownership interest." But it is axiomatic that a third-party beneficiary cannot claim more rights under the contract than that of the first-party rights it relies on for enforcement." Alvarado (Bland, J., dissenting) at 11.
We take two lessons from Alvarado. First, it teaches that force placed policies may provide more coverage than a lender or insurer will later argue they anticipated. Policyholders in the unfortunate position of being subject to force placed coverage should not relinquish this possible source of coverage without closely examining the force placed policy for which they are being billed.
More importantly, however, is the need to recognize principles and considerations applicable in one situation, and to bring them to bear on new circumstances (such as those accompanying climate change). Lending institutions may be in the crosshairs as flood risks develop in the coming years and bank real estate portfolios are threatened. The numbers on which these portfolios were underwritten will no longer represent reality in that the risk of loss will be higher than anticipated. To protect themselves, banks may attempt to force place coverage. As Alvarado shows, however, the bank may come up short as the bank's borrower may have a claim on that protection.