Lenders always want to make sure that borrowers properly insure their property to the level that their valuers have recommended. A lender’s objective is, after all, to ensure that the value of the property - the underlying security asset - is preserved.
But there’s more to insurance than simply requiring a policy to be in place and for the cover to be at an adequate level.
What is a lender’s position if there is damage by an insured risk? Huw Thomas, in the Banking and Finance team, looks at different possible approaches.
‘Noting’ a lender’s interest on a policy does not give it the right to claim directly against an insurer and receive the insurance proceeds. The insurer is ‘on notice’ that the lender has an interest in the property.
Is noting sufficient? Probably not. In the words of one large insurer, noting ‘achieves little for the lender as it has no specific legal effect’.
And yet we see lenders routinely asking us to ensure their interest is merely noted. Why might that be?
Some lenders think that an insurer would always notify the ‘noted’ lender of any cancellation or alteration of cover – and allow a brief period for the lender to put alternative cover in place. That’s certainly what was set out in an agreement between the Association of British Insurers and the British Bankers’ Association covered. However, this agreement fell away in 2012…
First Loss Payee
This is an instruction that designates a third party to be paid out on a claim, in priority to the insured party. This is often expressly limited to any claim above a particular level, so that small claims are settled directly with the borrower.
Gareth Cotty of Thomas Carroll insurance brokers tell us that this threshhold is typically around £50,000. The lender’s position is greatly improved, and this provision should come at no additional cost for the cover. There is perhaps one practical downside for the borrower: the insurance payout is not directed towards making good the damage to the property.
Non-invalidation clause (sometimes called a ‘non-vitiation clause’)
The first loss payee clause alone might not be much comfort to a lender. An insurer can refuse to pay out if the borrower has not complied with a policy condition or has made a material misrepresentation before the policy was entered into. A well-advised lender should seek an assurance that the policy includes a non-invalidation clause. Most insurers now seem to accept this type of clause but the wording will need to be checked. Certainly, there does not seem to be any common approach in the insurance market on such clauses.
Composite insurance (or ‘co-insurance’)
Composite insurance exists where two or more parties with a separate interest in a property are insured under the same insurance contract. A co-insured party is able to claim against an insurer and be paid directly under the policy. It is not prejudiced even if the other has fallen foul of the policy conditions. A non-invalidation clause is therefore not required. However, this type of arrangement does come at a cost. According to Thomas Carroll, where an insurer agrees to composite insurance, the cost of the premium typically goes up by some 15-20% (since, in effect, two policies are being issued).
Noting, composite insurance, first loss payee, non-invalidation…HELP!
A prudent lender should understand the implications of the insurance demands it makes on borrowers and appreciate the practical impact for both borrower and insurer.
Nick Pester, Capital’s Head of Insurance, says:
‘This is not only a complex area of the law but a complicated commercial issue in that it requires a careful balancing of interests between insurers and lenders. Noting an interest appears to generally be the norm although it presents little protection to the lender in the event of a ‘renegade’ insured / borrower. Conversely, the more protection that is sought for the lender, the greater the impact on the policy premium. It’s something which therefore needs to be considered on a ‘case by case’ basis.’
Do please get in touch with Huw or Nick to chat through your own requirements.