Increasingly, financiers are utilising insurance policies as a means of protecting loans and/or underlying assets as well as, if possible, addressing unfunded Capital Risk Mitigation (CRM) issues. As will be seen, where the borrower has been required to take out the policy, certain issues may materialise which could well prevent the borrower and/or the financier recovering under the policy. Where the financier takes the policy out as the principal named insured these issues do not arise, although clearly we would advise that the policy is scrutinised for the purpose of ensuring that the underlying risk maps into the policy wording and that policy defences are neutralised where possible (e.g. removal of conditions precedent or, at the very least, the dilution of their impact).
It has often been the case that where insurance was required as part of the lending package (until the last decade), little attention was paid to the robustness or otherwise of an insurance policy. However, increasingly, financiers scrutinise the insurance policies provided to ensure they give the necessary protection and security in the event of the failure of the borrower to repay any loans or the failure to realise the underlying security.
When considering a policy there are five basic steps which should be kept in mind:
- Unless there are compelling reasons to do otherwise, we would advise financiers to be co-insureds under the relevant policies. The principal requirements for protecting the financiers’ interests are (a) for the financier to be a named or additional insured under the policy and (b) to ensure that the policy is a composite policy. The normal means of effecting this outcome is to note that the financier is an insured together with other insured entities “in respect of their respective rights and interests”. The latter wording ensures that the policy will be viewed as a composite policy. We would recommand that it should be noted, for the avoidance of doubt, that the issued policy should be regarded as composite.
- It follows in the usual course of events that if the financier is an insured under the policy it is required to disclose material information to the insurer (or, possibly, complete a proposal form). The solution to this is to expressly state that the financier has no duty of disclosure. Given that it is often the borrower which is required to obtain the policy and complete the proposal form, it is the borrower which has the relevant information. We would add that if there are instances where disclosure is required of the financier the impact of non-disclosure can be addressed by innocent non-disclosure clauses as well as limiting disclosure to specified individuals or departments.
- Following on from points 1. and 2., if there is by the borrower (a) a non-disclosure or misrepresentation which would entitle the insurer to avoid the policy, (b) a breach of warranty which would terminate the policy from the date of the breach (irrespective of the relationship of the breach to the loss which has occurred) or (c) a failure to comply with a condition precedent, then such event will only impact the borrower which has effected the breach. Any remaining insured will remain covered as a result of the policy being stated to be a composite policy and an express non vitiation provision (i.e. avoidance acts of one insured will only entitle insurers to avoid against that insured and not other, innocent, coinsureds).
- Provision should be made with regard to the administration of the policy e.g. the payment of premium, destination of proceeds, notification to the financiers of material changes and cancellation and non renewal of the policy.
- We would not recommend that financiers are simply noted as loss payees under the policy. The reason for this is that if the borrower is the sole insured under the policy and a defence arises due to non-disclosure or mis-representation, the financier would be in no better position than the borrower given that the policy would be avoided ab initio.