Lenders are continuing to make specific requirements in relation to the type of insurance that borrowers should hold for secured properties. Largely, this is due to the lasting impact of the withdrawal of the Association of British Insurers (ABI) from their 1992 agreement with the British Banking Association (BBA) in 2012. This agreement had provided a safety net to lenders as insurers had agreed to advise banks if a policyholder had failed to renew the policy or reduced the cover. Following termination of the agreement, banks can no longer rely on this type of notification.
Since this change lenders more carefully consider what they can do to protect their interest and security including any requirements they would like borrowers to comply with when taking out or renewing insurance policies.
Set out below are our two top tips for lenders to consider in this context. Both of these will need to be considered alongside the perspective of an insurer and what they are prepared to accept.
Tip 1 – consider becoming a composite insured
Being a composite insured gives a lender the best level of protection. It is therefore potentially a crucial safeguard to protect its interest in a borrower’s insurance policy. However, it is a burdensome option for insurers and therefore is mainly used in large value transactions only.
Under this arrangement, the lender and the borrower are treated independently by what are effectively two separate policies. As the lender is insured in its own right, if the borrower were to do anything to invalidate the cover then the lender would maintain its independent right to claim for any of its losses.
As the lender will be an insured under the policy it will be subject to the usual insured’s duties (such as disclosure). Because of the nature of being a lender they may not hold all of the relevant information to fulfil all these duties. Therefore, a lender must consider what duties they can meet and if duties cannot be met they should be excluded.
Is being a composite insured different from the borrower and lender being ‘joint insured’?
Yes – it is important to note this is different from the borrower and the lender being ‘joint insured’ on a policy whereby the parties are treated as having an identical interest in the secured property. In this case, a joint policy is taken out in both their names and neither party can recover more than their individual loss.
Is being a composite insured different from the lender being ‘noted’ on the policy?
Being a composite insured is also notably distinct from the lender being ‘noted’ on the policy and provides much greater protection in cases of default by a borrower. Protection under this arrangement is limited, as this does not entitle a noted party to claim, take priority or enforce any rights under the policy. This could leave a lender exposed should a borrower breach any of the terms, as the insurer is only required to inform the third party if the policy is cancelled or not renewed.
Tip 2 – consider being listed as first loss payee
A lender should also consider requesting that they be listed as first loss payee on an insurance policy. An authorised designated first loss payee is entitled to receive any proceeds paid out under the policy, in practice limited to receiving larger sums (usually over £10,000).
This arrangement is particularly advantageous because a designated payee does not have any obligations under the policy. However, compliance with the policy conditions will be necessary (which is something to bear in mind if the conditions look to be particularly onerous).
First loss payee clauses are usually acceptable to insurers since a designated third party has no independent right to make a claim under the policy and the insurer is only obliged to deal with one insured party (if the lender is not party to the policy). In addition, the insurer’s obligation to pay the first loss payee depends on the borrower being able to recover under the policy, so if the borrower has breached the policy then the insurer can still decline to pay out. This type of protection is certainly a suitable alternative to a lender having only their interest noted on the policy, especially if a lender is unable to secure composite status.
We would always advise that lenders think about their particular insurance requirements as early on in a transaction as possible, to ensure that the borrower has sufficient time to discuss such matters with their insurer.
If you have any queries in relation to this article, please do not hesitate to contact one of Thomson Snell & Passmore’s Real Estate Finance experts firstname.lastname@example.org.