Property Insurance Coverages, Part II, An Overview
Dan Harkey, at DanHarkey.com writes great articles about real estate on his website. You can read more articles by visiting his website. In this article, he discusses “Property Insurance Coverages, Part II, An Overview”
This overview of property insurance has relevance to property owners, real estate agents & brokers, mortgage agents & lenders, insurance agents & brokers, escrow officers, and title insurers.
The article is broken down into part I and part II. Part I pertains to insurance in general. Part II pertains to insurance in relation to real estate transactions.
This is the beginning of Part II. The following subjects will be covered.
a) Language in deeds of trust and mortgages that requires replacement cost coverage.
b) Insurance binders and certificate of insurance.
c) How do mortgage lenders protect their financial interest in the event of a reimbursable insurance claim?
d) Insurance disclosures in a borrower loan application.
e) Loan processing ordering insurance coverage on behalf of the borrower.
f) The Property Appraisal process.
g) Types of insurance available relating to the real estate industry. Short-snippet definition of each coverage is included.
Language in deeds of trust and mortgages that pertains to the requirement of replacement cost coverage:
Here is an example from a deed of trust.
“Insurance (“Building Insurance”) on all buildings, fixtures, and improvements located on the Trust Property against fire and “special perils” (including “ordinance or law coverage”), in amounts at least equal to the greater of:
(a) the full replacement cost thereof (without deduction for depreciation) as such replacement cost shall be determined from time to time at the reasonable request of Beneficiary; or
(b) unless prohibited by law, the unpaid principal amount of the indebtedness. The Building Insurance shall include a coinsurance waiver or agreed amount endorsement for zoning and law coverage and betterments and enhancements coverage. During any construction, such insurance shall be on Special Form Builder’s Risk 100% Completed Value Non-Reporting Form or other form approved by Beneficiary(s).”
Lenders should rely on their counsel to draft related language. Insurance binders and certificate of insurance. In the real estate transactional business, an insurance broker or the insurer will issue a notice called a binder of coverage to an escrow holder and a real property lender during the escrow period. An insurance binder is fully enforceable temporary insurance coverage reflecting the type of coverages, number of coverages, deductibles and coverage limits, and conditions. The binder is a temporary insurance contract between the insured party and the insurance company. The binder may be issued by the insurance broker, an agent of the insurer, or by the insurer itself. The binder provides full coverage while the insured party waits for the full policy to be delivered. The binder dissolves when the full policy is issued. Binder coverage may remain in effect for 30 to 90 days. A binder is not the same as a certificate of insurance. A certificate may be produced after the policy has been issued. While the certificate is evidence of insurance, it is not an insurance policy. It is a notification of the existence of coverage.
How do lenders protect their financial interest in the event of a reimbursable insurance claim?
The lender will require an insurance broker or company to add them as an “additional named insured” on the binder page or face sheet. Lender(s) makes real estate loan(s) subject to the borrower obtaining required coverage and agreeing to make timely premium payments. How does a lender know whether the borrower has made timely insurance premium payments? How are lenders notified if premiums are not paid and coverage lapses? Insurance claim checks made out to dual parties can be problematic. The fact that the lender is named as an additional insured does not obligate the insurance company to do anything other than to pay an insured claim with a check naming both the insured party (borrower) and the lender. In some cases, the insured party (borrower) has received the claim proceeds check with both names as payees, only to endorse for themselves and fraudulently endorse as the lender party. However, there is a remedy so that this cannot happen.
Without a properly constructed endorsement, a borrower’s payment default on premiums will result in an insurer canceling the policy. Without an adequately worded endorsement, the insurer has no requirement to notify the lender of the cancellation. Only with the properly constructed endorsement will there be the creation of a written mutually protective agreement between the insurance company and the lender. What is the difference between a loss payee and a lender’s loss payee?
1) A loss payee is a party or entity (borrower) and primary insured who has a financial interest and expects to get paid first in the event of an insured loss payout.
2) A standard loss payee provision does not constitute any mutual obligation or agreement between an insurance company and a lender.
3) A lender’s loss payee clause is an insurance contract endorsement. An insurer has an obligation to communicate with a lender and pay a claim in dollars to the lender instead of the named insured party (borrower).
4) Protection of the security interest by a lender and payout of an insurance claim proceeds to the lender is paramount to the integrity of real estate lending.
The endorsement 438 BFU or BFU NS is referred to as a “Lenders Loss Payee Endorsement,” which should be signed by the insurance carrier and held in the insurers and the lender’s files. Without a 438 BFU or similar endorsement, a lender will be subject to the risk of a borrower misappropriating payouts of insurance claims. The 438 BFU endorsement is an agreement between the insurance company lender that states if the company is going to cancel the policy because of a non-premium payment, the company will notify the lender and give the lender time to make the payment. Some mortgage brokers, real estate brokers, and lenders may be under the assumption that the mere naming of the lender as an additional insured is adequate. It is not!
I have been a consultant and investigator representing an insurance company in a situation where the insurer issued a claim proceeds payout check to the defaulted borrower. The check named both the defaulted borrower and the property lender as payees. The defaulting borrower endorsed the check and absconded with the proceeds. My job was to identify the fraud and work with a lawyer to sue the perpetrator to recover the misappropriated funds. Filing a court action against someone who has zero integrity and whose financial back is against the wall is futile. The original 438 BFU NS was released on May 1, 1942. Since the original, carriers have written their version with a different identification number but with the same substantive protections between the lender and insurance carrier.
Insurance carriers may use 438 BFU or a similarly worded form using their reference number.
2) American Modern–73259
4) Tower Select–HOIV 2001 0608
5) State Farm FE 1313, which is a 438 by a different name
Borrowers, mortgage brokers, and lenders should understand that a 438 BFU endorsement is an agreement between the lender and the insurance company. It is not an agreement between the borrower and the lender. Many realtors and loan agents do not understand the distinction. Note that I have repeated this.
Borrower disclosures relating to insurance in a loan application package.
1) The loan agent or mortgage company representative will provide insurance-related disclosures to the prospective borrower as part of the loan package contents. Below is disclosure language like those used in the industry:
“Certain insurance coverages that comply with both borrower and lender protection requirements are part of your real estate transaction. Specific coverages must be obtained and maintained during the life of your loan. To assist you in providing acceptable insurance coverage, the following are the minimum requirements:”
a) The insurance carrier must be rated at least an “A-, VII” from AM Best’s Key Rating Guide.
b) The insurance carrier must be licensed and registered to do business in the same state as the collateral property; and
c) The lender must be listed on the insurance policy on the lender loss payable endorsement and as mortgagee/certificate holder/additional insured as follows:
Any Lender USA, Inc., as
Manager) or (Designated Agent for Beneficiaries)
The Successors and assigns (Lender)
d) The complete property address for each insured property must be shown on the policy’s declaration page or other evidence of insurance.
e) The insured name must match the same vesting for the property and the loan. A family trust or LLC can be added as an additional insured.
f) The Insurance policy number must show on the endorsement.
g) The loan account number must be shown on all policies and correspondence.
h) The maximum deductible may not exceed $5,000.
i) The lender must be provided at least a 30-day written cancellation or material change notice.
j) Lender must hold an original policy and any replacement policy or renewal policy with a binder, and the original of all endorsements to such policies.
2) Actual borrower insurance authorization to be emailed or faxed to the insurance broker of record:
“Dear Insurance agent,
I have applied for mortgage financing to be arranged by George & Louise Jefferson’s Lending Company. I hereby authorize you to speak directly with lender representatives regarding my policy and insurance requirements. Their general requirements are as follows:
a) Twelve months’ hazard policy in the amount of the replacement cost of the improvements, with the declarations page naming the below as Mortgagee, Lender Loss Payable, and Additional Insured:
b) 438BFU, 438BFU NS lenders loss payable endorsement attached.
c) The insurance carrier must be rated at least an “A-, VII” from AM Best’s Key Rating Guide.
d) Six (6) months’ premiums must be paid prior to or upon funding.
e) General liability policy of not less than one million dollars or such amount approved by the beneficiary (lender).
f) The designated agent for beneficiaries must hold an original policy, declarations page, renewal policy with a binder, and the original of all endorsement to such policies within 30 days.
J) Twelve months’ rent loss coverage or actual loss sustained is necessary for any income-producing property.
We appreciate your immediate attention.
Signed Borrower(s). Mr. Archie and Edith Bunker.
Loan processing and underwriting tasks to order property insurance.
As restated above, the loan processor for the lender will use preprinted forms directed to the borrower’s insurance broker to notice that there is a loan in the process. These forms are from the borrower which instructs the insurance broker to communicate with the loan processor about the required coverages. Insurance requirements will be contained in a lender disclosure as part of the loan application package sent. Here is a sample of the actions taken by the lender and communicated to the borrower and their insurance carrier.
1) The loan processor for the lender will email a notice to the insurance agent stating that you are the agent of the principal borrower.
2) When coverage verification is received, the processor or underwriter will need to analyze the coverage to determine its sufficiency. Contact the principal to determine adequacy.
3) For new insurance policies, the processor or underwriter must work with the borrower and borrower’s insurance agent to discuss options and the appropriateness of the decision.
4) In most cases, commercial coverage will require an onsite inspection by the insurance carrier and an appraisal process.
5) Determine whether proof of insurance binder or an actual policy is needed.
6) Upon receipt of the loan package, the borrower and loan agent will discuss the following:
a) Contact their insurance broker or carrier to request insurance information.
b) Make a written request for the desired coverage. Extended replacement cost coverage is a preference.)
c) Segregate personal property coverage to be addressed with the principal and the insurance broker.
d) Amounts of deductibles will be determined.
e) General blanket liability coverage should be determined.
f) Will the borrower pay for insurance separately or as part of his escrow down payment?
g) The insurance carrier has no specific duty to inform the lender whether the actual policy coverage was denied, and no policy was issued
h) Order special coverage endorsements when appropriate.
i) Draft closing instructions to the escrow agent, which should
include language like:
“Original Hazard Insurance Policy Declaration with replacement cost covers in the amount of $___________________.” “Original General Liability Insurance Policy Declaration with coverage in the amount of $___________________.” “Original Course of Construction Insurance Policy
The Property Appraisal process:
As part of the loan application process, an appraisal will be obtained to determine the appraised value of the entire property. The lender/mortgage broker may request that the appraiser supply a replacement cost analysis using today’s standards, segregating the value of each component included in the replacement cost of the dwelling, land (opinion of site value,) appurtenances, garage, site improvements, and landscaping. Usually, the appraiser will subtract depreciation for wear and tear (physical, functional, external), coming up with a “net adjusted indicated value by the cost approach.”
Lenders may use the appraiser’s calculations to determine the required replacement cost estimate of all the real property components, excluding the value of the land parcel. The lender may use this replacement cost estimate to determine the amount of required coverage. The current replacement cost of a 2000-square-foot home may be $800,000, but with the allowance for depreciation deducted, the value may be adjusted down to $400,000. Depreciated value considers accumulated loss of value from wear & tear and deterioration. A “replacement cost policy” may pay out the entire $800,000, while the “actual cash value” policy may pay only the $400,000.
Sometimes there may be a deviation/conflict between the appraiser’s estimate of the replacement cost and what the insurance company representative suggests. The difference in calculations may be substantial. The required amount(s) of coverage may need to be negotiated between the lender, mortgage broker, borrower, and the insurance company. Let’s assume that the appraiser believes that the replacement cost is $1,000,000, but the insurance carrier agent says that it is $600,000. Let’s assume that the new loan is $700,000. Even though this is a substantial difference, the lender who is originating/making the loan will first look at the amount of the loan balance and the value of the land parcel segregated from the structures to determine the risk of loss. The lender may agree that a $700,000 insurance policy will be enough coverage. The insurance carrier includes an endorsement that if the cost is higher because of current codes and zoning changes, the higher cost will be covered. As discussed above, this is referred to as betterment and enhancement or code compliance coverage.
The cost difference between replacing a structure as it was originally constructed and replacing it with a structure with updated current requirements could be as much as 100% higher or more. This will most likely require changes in property configuration based on front/side setbacks, construction materials, zoning changes, parking requirements, etc. A betterments and enhancements endorsement to a replacement cost coverage policy is an add-on or addition or additional insurance. The lender will require an insurance broker or company to add them as an “additional named insured” on the binder page or face sheet. Lender(s) makes real estate loan(s) subject to the borrower obtaining required coverage and agreeing to make timely premium payments. How does a lender know whether the borrower has made timely insurance premium payments? How are lenders notified if premiums are not paid and coverage lapses? Without a properly constructed endorsement, a borrower’s payment default on premiums will result in an insurer canceling the policy. Without an adequately worded endorsement, the insurer has no requirement to notify the lender of the cancellation. Only with the properly constructed endorsement will there be the creation of a written mutually protective agreement between the insurance company and the lender.
Types of insurance available relating to the real estate industry.
Terms of insurance coverage vary from state to state. A word of caution! Do not rely on this list for your insurance requirements! Contact a qualified insurance agent to discuss your needs and various coverages. Residential 1-4, owner-occupied, income-producing, and commercial properties: Standard policies cover dwelling, other structures, personal property, and liability.
a) Homeowner-HO-2,3,5 condo/co-HO-6, mobile/modular home-HO-7. Ho-8 is for older buildings where the replacement cost potentially outweighs the market value.
b) Commercial lines-Income property.
c) Owner-occupied, personal property (contents coverage) and liability.
d) Renter’s insurance, personal property, and liability. HO-4 specifically for renters.
e) Comprehensive general liability for all (referred to as a blanket liability rider).
f) Workman’s compensation for workers on income property.
g) Loss of rents for owners of an income property. Coverage provides insurance when a commercial building is damaged and cannot be occupied. This coverage applies to both owner- occupied and non-owner-occupied properties.
h) Business personal property contents on income property such as washer and dryers, workout gym equipment, kitchen, game room, and pool equipment.
i) Forced order provides coverage when borrowers default due to non-payment of the premiums. A lender will pay (advance) the premium to protect their security interests.
j) Course of construction during original or rehabilitation construction. Contractor insurance has its own subset of coverages. These include the course of construction, subcontractor’s general liability, workers’ comp, builder’s risk, completed operations, equipment, on-site theft, etc.
Special Coverage Endorsements.
Standard coverages exclude nuclear, biological, chemical, radioactive, terrorism, etc. Special coverage endorsements are available from different carriers for different risks. Endorsements/riders amendments (add-ons) change the terms of the existing insurance contract. Endorsements may be purchased at the time of property purchase, mid-term, or renewal. Premiums will reflect an additional cost to the original policy for each separate endorsement.
a) Scheduled personal property-supplemental coverage to extend beyond the coverage of the homeowner’s policy. Special riders are available for unique personal property such as cash, jewelry, wedding rings, firearms, furs, gold, accidental breakage, damage, or mysterious disappearance (lost, or misplaced).
b) Water/sewer backup covers damage to your property caused by clogged sewer lines, failed sump pump, and backup drain. The coverage also covers mold damage to the property caused by water or sewer backup.
c) Flood coverage provides coverage for the dwelling and additional structures to be covered in the event of a flood. https://www.nh.gov/insurance/consumers/documents/summary_cov.pdf
d) Earthquake- provides coverage for the dwelling, and additional structures, caused by an earthquake. Earthquake damage is typically excluded from a homeowner’s policy and must be purchased separately.
e) Identity theft is designed to cover expenses related to reclaiming their financial identities and repairing their credit.
f) Canine liability.
g) Additional Insured is what the entire article is about. The lender’s loss payee endorsement is of paramount importance.
h) Building Ordinance- (definitions and coverages vary)-a form of insurance associated with the cost of repairing a building and bringing it up to current codes.
i) Betterments and enhancements-provides coverage for fixtures, alterations, additions, or installations made a permanent part of the building and at the expense of the tenant, which may not be legally removed.
j) Environmental hazards liability insurance.
k) Employee theft, employee dishonesty coverage.
Ongoing business concern coverage:
Besides the business owner’s policy, most coverages are add-on endorsements. Add-on means additional coverage for an additional fee.
a) Business owner’s policy-combines business property and business liability into one insurance policy.
b) General Liability Insurance- protection against common customer or client incidents, including bodily injuries, property damage, and advertising injuries.
c) Employment practices liability-covers wrongful acts arising from the employment process. Claims may include wrongful termination, discrimination, sexual harassment, or retaliation.
d) Directors’ and officers’ liability-Protects the personal assets of corporate directors and officers, and their spouses, in the event they are personally sued by employees, vendors, competitors, investors, customers, or other parties, for actual or alleged wrongful acts in managing the company.
e) Management liability- a package of insurance policies designed to Protect a business and its directors, offices, board members, managers, and administrators from lawsuits alleging mismanagement.
f) Product liability-a package of policies designed to protect a business and its directors, officers, board members, managers and administrators from lawsuits alleging mismanagement.
g) Keyman life and disability-provides financial assistance to a business if a key person dies or extended incapacity of a key person in management.
h) Professional liability-provides coverage for professionals and businesses to protect against claims of negligence from clients or customers.
i) Credit insurance- will pay off one or more existing debts in the event of death, disability, or in some policies, unemployment.
j) Commercial auto-covers multiple drivers, multiple vehicles, trucks, and employees, even with a poor driving record.
k) Umbrella liability policy-extra insurance that provides protection beyond existing limits and coverages of other policies.
l) Workman’s compensation-provides benefits to employees who suffer work-related injuries or illnesses.
m) Cyber liability-many options to protect the company from data breaches and other cyber security issues.
n) Business interruption-replaces income lost in the event a business operation is halted due to direct physical loss or damage caused by natural disasters.
o) Errors & omissions-protects companies against the full cost of a claim made by a client against a professional who provides advice or service as a salesperson, consultant, advisor, agent, or lawyer.
p) Fidelity bonds-business protection against financial loss caused by an employee’s dishonest conduct.
Although Automobile insurance is not directly related to real property insurance there is a lot of overlap in required coverages for areas like employees using a
company car, employees using a personally owned car for occasional business, etc. That is why I included this section. Besides collision coverage, most of these coverages are add-on endorsements.
a) Collision -pays for repairs or replacement of a car if it is damaged in an accident.
b) Comprehensive- adds coverage to repair a stolen or damaged vehicle in an incident that is not a collision. Examples would be fire, vandalism, or falling objects.
c) Liability- pays for property damage or injuries to another person caused by an accident in which you are at fault.
d) Medical payments-pays for medical expenses for an insured who sustains bodily injury caused ab an automobile accident, regardless of fault.
e) Personal injury-known as no-fault insurance, covers expenses like medical bills, lost wages, or funeral costs after an accident, no matter who is at fault.
f) Uninsured motorist- you pay the premium for someone who does not have insurance- you are able to file a claim with your own insurance carrier for damages caused by a driver with no insurance.
g) Towing and labor- coverage for reimbursement of common roadside breakdowns.
h) Rental car reimbursement-will pay for transportation expenses, such as a rental car, while your car is being repaired.
i) Classic car-self-explanatory- cheap.
j) Motorcycles, motorhomes, and travel trailers usually require a special rider on your auto policy.
Life and disability:
Most policies are separate coverages.
a) Term life & whole life policies
b) Supplemental disability-protect your income in the event of sickness or an accident that prohibits you from working. Can purchase short-term or loan-term disability insurance.
c) Mortgage disability-this type of insurance is meant to cover some or all your mortgage loan payments in the event of illness or injury.
d) Disability overhead expense-overhead expense insurance reimburses a business owner for business expenses during the time of disability
e) Disability insurance protects the continued income or paycheck; if the insured loses the ability to work due to illness or injury.