Real Property Insurance: Part III of III

Deeds of trust and mortgages contain language that pertains to the requirement of replacement cost coverage:

• The security instruments, deeds of trust, and mortgages recorded against the property have specialized language relating to the borrower's requirement to obtain acceptable coverage. The required coverage protects the borrower's (insured party) and the lender's (beneficiaries) interest.

Example of language in the 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:

• The total replacement cost thereof (without deduction for depreciation),
• The replacement cost shall be determined from time to time at the reasonable request of the lender (beneficiary) or
• Unless the law prohibits the unpaid principal amount of indebtedness.  The Building Insurance shall include a coinsurance waiver or agreed amount endorsement for zoning and law coverage and betterments and enhancements coverage.  During 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 must rely on their counsel to draft related language, as their expertise ensures the adequacy and enforceability of the insurance requirements.

Binders and certificates 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 property lender during the escrow period. An insurance binder is a fully enforceable temporary insurance coverage.
• Reflecting coverages, deductibles, coverage limits, and conditions. The binder is between the insured party and the insurance company. The insurance broker, an insurance agent, or the insurer will issue the binder.
• The binder provides full coverage while the insured party waits for the full policy to be delivered. The binder dissolves when the written policy is issued. Binder coverage may remain in effect for 30 to 90 days.
• It's important to note that a binder is not the same as a certificate of insurance. While the certificate is evidence of insurance, it is not an insurance policy. It is a notification of the existence of coverage. Conversely, a binder provides full coverage while the insured party waits for the full policy to be delivered. The binder dissolves when the written policy is issued. Binder coverage may remain in effect for 30 to 90 days.
• Reimbursable insurance claims: How do lenders protect their security interest in the payout proceeds?

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) play a crucial role in real estate loan(s), subject to the borrower obtaining the required coverage and agreeing to make timely premium payments. Their vigilance ensures the smooth operation of the insurance process. How does a lender know whether the borrower has made timely insurance premium payments? How are lenders notified if the borrower defaults and fails to pay the premium or coverage lapses?

Insurance claim checks naming dual parties (the borrower and the lender) can be problematic. Even though the lender is called an additional insured, the insurance company is not obligated to notify of anything. The company must only pay an insured claim with a check detailing the insured parties (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 themselves and fraudulently endorse as the lender party. However, there is a remedy that can prevent this from happening, and it's essential to be aware of these potential risks.

Without a properly constructed endorsement, a borrower's default payment on premiums will result in an insurer canceling the policy. This underscores the need for an adequately worded endorsement, which is the only way to ensure the insurer has a requirement to notify the lender of the cancellation. Only with the properly constructed endorsement will a written mutually protective agreement between the insurance company and the lender be possible, providing a sense of security and protection.

Loss payee and a lender's loss payee- What is the difference?

• A loss payee is a party or entity (borrower) and primary insured with a financial interest and expects to get paid first in the event of an insured loss payout.
• A standard loss payee provision does not constitute any mutual obligation or agreement between an insurance company and a lender.
• A lender's loss payee clause is an insurance contract endorsement. An insurer should communicate with a lender and pay a dollar(s) claim to the lender instead of the named insured party (borrower).
• The integrity of real estate lending depends on protecting a lender's security interest and the payout of insurance claim proceeds to the lender.

Lender's Loss Payee Endorsement:

The New York Standard Mortgage Clause (438 BFU) was created on May 1, 1942. It is a standard provision in many insurance policies that protects the lender in the event of a borrower's default. Since then, carriers have written their version with different identification numbers but with the same substantive protections between the lender and insurance carrier.

The 438 BFU endorsement is an agreement between the insurance company and lender that states that if the company cancels the policy because of a non-premium payment by the insured party (the borrower), the company will notify the lender and give the lender time to make the payment.

The endorsement 438 BFU or BFUNS should be signed by the insurance carrier and held in the insurers' and the lenders' files. Without a 438 BFU or similar endorsement, a lender is subject to the risk of a borrower misappropriating insurance claims proceeds.

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 where the insurer issued a claim proceeds payout check to the defaulted borrower. The claims check named the defaulted borrower and the property lender as payees. The defaulting borrower endorsed the claims stem and absconded with the proceeds. I identified the fraud and worked with a lawyer to sue the perpetrator to recover the misappropriated funds. Filing a court action against someone with zero integrity and whose financial back is against the wall is futile.

The New York Standard Mortgage Clause (438 BFU) was created on May 1, 1942. Since then, carriers have written their versions with different identification numbers but the same substantive protections for the lender and insurance carrier.

Insurance carriers may use 438 BFU or a similarly worded form using their reference number.

https://www.insurance.wa.gov/sites/default/files/documents/438-bfu-ns.pdf

• Allstate AU319
• State Farm FE 1313, which is a 438 by a different name

The Loan processor will provide borrowers with disclosures relating to the lender's loss payee requirement for their insurance in a loan application package:

Below is disclosure language like that used in the industry:

• Certain insurance coverages that comply with borrower and lender protection requirements are part of your real estate transaction. Specific coverage 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:
• The insurance carrier must be rated at least A-, VII by AM Best's Key Rating Guide.
• The insurance carrier must be licensed and registered to do business in the same state as the collateral property and
• The lender named 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)
• Lender's address
• The complete property address for each insured property is on the policy's declaration page or other evidence of insurance.
• The insured's name must match the same vesting for the property and the loan. A family trust or a limited liability company holding title may be added as an additional insured.
• The insurance policy number must be shown on the endorsement.
• All policies display a loan account number on all policies and correspondence.
• The maximum deductible may not exceed $5,000.
• The insurance company requires a 30-day written cancellation notice or material change notice.
• The 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.

Borrower insurance authorization to be emailed or faxed to the insurance broker of record:

Dear Insurance agent,

I have applied for mortgage financing arranged by George & Louise Jefferson's Lending Company. I am writing to inform you that I authorize you to speak directly with lender representatives regarding my policy and insurance requirements.

Their general requirements are as follows:

• 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:
• 438BFU, 438BFU NS lenders loss payable endorsement attached.
• The insurance carrier must be rated at least A-, VII by AM Best's Key Rating Guide.
• The borrower must pay six (6) monthly premiums before or upon funding.
• A general liability policy of not less than one million dollars or such other amount as approved by the Beneficiary (lender).
• The designated agent for beneficiaries must hold an original policy, declarations page, renewal policy with a binder, and the original of all endorsements to such policies within 30 days.
• Twelve months of rent loss coverage or actual loss sustained is necessary for any income-producing property.
• "We kindly request your prompt attention to this matter. Sincerely, Mr. Archie and Edith Bunker, the borrowers."
• The loan processing and closing agent will assist the borrower in ordering proof of property insurance.

The lender disclosure was sent as part of the loan application package. As stated above, the lender's loan processor will use preprinted forms directed to the borrower's insurance broker to inform them that a loan is being processed. The borrower will instruct the insurance broker to communicate with the loan processor about the required coverage. Here is a sample of the lender's actions and communication with the borrower and their insurance carrier.

• The lender's loan processor will email a notice to the insurance agent stating that you are the principal borrower's agent.
• When coverage verification is received, the processor or underwriter analyzes the coverage to determine its sufficiency. The processor then contacts the principal to discuss the lender's requirements.
• For new insurance policies, the processor or underwriter must work with the borrower and the borrower's insurance agent to discuss options and the appropriateness of the decision.
• In most cases, commercial coverage will require an on-site inspection by the insurance carrier and an appraisal process.
• Determine whether proof of insurance binder or an actual policy is needed.
• Upon receipt of the loan package, the borrower and loan agent will discuss the following:
• Contact their insurance broker or carrier to request insurance information.
• Make a written request for the desired coverage. Extended replacement cost coverage is a preference.)
• Discuss personal property coverage with the principal and the insurance broker.
• Amounts of deductibles will be determined.
• Discuss why a blanket liability coverage endorsement is needed.
• Will the borrower pay for insurance separately or as part of his escrow down payment?
• If an insurance carrier denies the coverage initially requested, the lender is not obligated to inform it if the original insurance policy is issued.
• Order special coverage endorsements when appropriate.
• 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 Declaration $_____________.

Insurance and the property appraisal process:

An independent appraisal is required to determine the property's appraised value as part of the loan application process. 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 subtracts depreciation for wear and tear (physical, functional, external), generating a net adjusted indicated value by the cost approach.

Lenders may use the appraiser's calculations to determine the required replacement cost estimate for all the real property components, excluding the value of the land parcel. The lender may also use this replacement cost estimate to determine the amount of required coverage.

Depreciated value is the accumulated loss of value from wear and 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.

The required amount(s) of coverage is negotiated between the lender, mortgage broker, borrower, and insurance company. Calculations may differ substantially. Sometimes, there may be a deviation/conflict between the appraiser's estimate of the replacement cost and what the insurance company representative suggests.

Let's assume that the appraiser believes the replacement cost is $1,000,000, but the insurance carrier agent says it is $600,000. Let's consider 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 cover enough. The insurance carrier may endorse that higher costs are covered if the prices are higher because of current codes and zoning changes. As discussed above, this improves and enhances code compliance coverage.

The difference between replacing a structure as it was initially and replacing it with a structure with updated current requirements could cost as much as 100% or more. Current zoning and code compliance regulations will likely require changes in the property configuration, such as front/side setbacks, construction materials, zoning changes, parking requirements, etc.

A betterment and enhancements endorsement to a replacement cost coverage policy is an add-on 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.

The lender makes the real estate loan subject to the borrower obtaining the required coverage and agreeing to make timely premium payments. How does a lender know whether the borrower has made timely insurance premium payments? How is a lender notified if a borrower defaults, has delinquent premiums, or lapses coverage?

Without a properly constructed endorsement, a borrower's premium payment default 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. A written mutually protective agreement between the insurance company and the lender will be possible only with the properly constructed endorsement.

What types of insurance are available in the real estate industry?

A word of caution! Terms of insurance coverage vary from state to state. Refrain from relying 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.

• Homeowner-HO-2,3,5 condo/co-HO-6, mobile/modular home-HO-7. Ho-8 is for older buildings where the replacement cost outweighs the market value.
• Commercial lines-Income property.
• Consider owner-occupied, personal property (contents coverage), and liability.
• Renter's insurance, personal property, and liability. HO-4 specifically for renters.
• Consider the need for comprehensive general liability for all (a blanket liability rider).
• Consider the need for workman's compensation for workers on income property.
• Consider the need for rent loss coverage for income property owners. This coverage provides insurance when a commercial building is damaged and cannot be occupied. It applies to both owner-occupied and non-owner-occupied properties.
• Discuss the need for business personal property on income property, such as washers and dryers, workout gym equipment, kitchen, game room, and pool equipment.
• A forced order provides coverage when borrowers default due to non-payment of the premiums. A lender will pay (advance) the premiums to protect their security interests.
• Discuss the need for construction insurance during original or rehabilitation construction. Contractor insurance has a subset of coverage. These include the construction course, subcontractor's general liability, workers comp, builder's risk, completed operations, equipment, on-site theft, etc.

Special Coverage Endorsements:

Standard coverage excludes nuclear, biological, chemical, radioactive, terrorism, etc. Special coverage endorsements are available from different carriers for different risks. Endorsements/rider amendments (add-ons) change the terms of the existing insurance contract. Coverage endorsements are purchased during the original property purchase, mid-term, or renewal. Premiums will reflect an additional cost to the actual policy for each separate endorsement.

• Scheduled personal property supplemental coverage extends beyond the coverage of the homeowner's policy. Remarkable 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).
• Water/sewer backup covers damage to your property caused by clogged sewer lines, a failed sump pump, and a backup drain. It also covers mold damage caused by water or sewer backup.
• Flood coverage covers the dwellings and additional structures resulting from a flood.
• https://www.nh.gov/insurance/consumers/documents/summary_cov.pdf
• Earthquake—covers the dwelling and additional structures damaged by an earthquake. Earthquake damage is typically excluded from a homeowner's policy and must be purchased separately.
• Identity theft covers expenses related to reclaiming their financial identities and repairing their credit.
• Canine liability.
• This article covers additional insured. The lender's loss payee endorsement is of paramount importance.
• Building Ordinance- (definitions and coverages vary) is a form of insurance associated with repairing a building and bringing it up to current codes.
• Betterments and enhancements provide coverage for fixtures, alterations, additions, or installations made a permanent part of the building and at the tenant's expense that may not be legally removed.
• Environmental hazards liability insurance.
• Employee theft and employee dishonesty coverage.

Ongoing business concern coverage:

Besides the business owner's policy, most coverages are add-on endorsements. An add-on means additional coverage for an extra fee.

Business owner's policy- Provides protection that combines business property and liability into one insurance policy.

• General Liability Insurance- protects against everyday customer or client incidents, including bodily injuries, property damage, and advertising injuries.
• Employment practices liability covers wrongful acts arising from the employment process. Claims may include wrongful termination, discrimination, sexual harassment, or retaliation.
• Directors and officers liability- Protects the personal assets of corporate directors and officers and their spouses if employees personally sue them, vendors, competitors, investors, customers, or other parties for actual or alleged wrongful acts in managing the company.
• Management liability- a package of insurance policies designed to
• Protect a business and its directors, offices, board members, managers, and administrators from mismanagement lawsuits.
• Product liability is a package of policies designed to protect a business and its directors, officers, board members, managers, and administrators from mismanagement lawsuits.
• Keyman life and disability-provides financial assistance to a business if a key person dies or there is extended incapacity of a key person in management.
• Professional liability-Provides protection coverage for professionals and businesses against negligence claims from clients or customers.
• Credit insurance- will pay off one or more existing debts in the event of death, disability, or, in some policies, unemployment.
• Commercial auto insurance covers multiple drivers, vehicles, trucks, and employees, even those with poor driving records.
• Umbrella liability insurance that exceeds existing limits and coverages of other policies.
• Workman's compensation benefits employees who suffer work-related injuries or illnesses.
• Cyber liability: There are many options to protect the company from data breaches and other cybersecurity issues.
• Business interruption: replaces income lost for a business operation halted due to direct physical loss or damage caused by natural disasters.
• Errors & omissions- Protects companies against the total cost of a claim made by a client against a professional who provides advice or service as a salesperson, consultant, advisor, agent, or lawyer.
• Fidelity provides business bonding as protection against financial loss caused by an employee's dishonest conduct.

Automobile:

Although Automobile insurance is not directly related to real property insurance, there is much overlap in required coverages for areas like employees using a company car or employees using a personally owned car for occasional business. That is why I included this section. Besides collision coverage, most of these coverages are add-on endorsements.

• Collision -pays for repairing or replacing a car damaged in an accident.
• Comprehensive This adds coverage to repair a stolen or damaged vehicle caused by an incident other than a collision. Examples would be fire, vandalism, or falling objects.
• Liability pays for property damage or injuries to another person caused by an accident in which you are at fault.
• Medical payments- Provides protection for medical expenses for an insured who sustains bodily injury caused by an automobile accident, regardless of fault.
• Personal injury, known as no-fault insurance, covers medical bills, lost wages, or funeral costs after an accident, no matter who is at fault.
• Uninsured motorist: You pay the premium for someone who does not have insurance. You can file a claim with your insurance carrier for damages caused by a driver without insurance.
• Towing and labor. Coverage for expense reimbursement of common roadside breakdowns.
• Rental car reimbursement pays for transportation expenses, such as a rental car, while your vehicle is in the repair shop.
• Classic car- car-self-explanatory- designed for unique automobiles with classic or historic status. The coverage is relatively cheap.
• Motorcycles, motorhomes, and travel trailers usually require a special rider on your auto policy.
• Life and disability

Most policies are separate coverages:

• Term life and whole life policies
• Supplemental disability insurance protects your income in the event of sickness or an accident that prohibits you from working. You can purchase short-term or loan-term disability insurance.
• Mortgage insurance: This type of coverage covers some or all of your mortgage loan payments in the event of illness or injury.
• Disability overhead expense insurance reimburses a business owner for business expenses during a disability.
• Disability insurance protects the continued income or paycheck if the insured loses the ability to work due to illness or injury.

My comments are meant for general education and are not all-encompassing, including the information in parts I, II, and III. The information contained is intended to be an educational overview only. Property insurance is a complex subject and is made more complicated by regulatory requirements, the health of the economy, inflationary pressures, and liability. Any owner/borrower or lender/mortgage broker should consult with a highly competent personal line or commercial insurance specialist to guide them to appropriate and contingent liability coverages. Remember, a qualified insurance specialist lawyer.

This concludes parts I, II, and III.