Offering a helping hand with real estate finance
Real estate lending has become trickier to obtain since the financial crisis, and as a consequence the inclusion of onerous insurance terms within loan agreements is now commonplace.
Following the financial crisis in 2008 the banking industry has been trying to de-risk real estate lending. But that risk did not disappearĶ¾ it was merely being transferred to the insurance industry, by lenders requiring protections against shortfall or vitiation of insurances covering the loan security.
This became a regular issue and with the current twin issues of the effects of the pandemic and the fall out from our exiting the European community there are likely to be even more complex deals and more onerous requirements on both the borrowers and hence the insurers.
Historically, the previous ABI/BBA agreement effectively meant a lenders interest in a property would be noted on an insured’s policy and the lender would be notified if that policy were cancelled.
A breakdown of terms
Misunderstanding the terms?
- Composite insured: While banks may request to be co-insured, they are actually looking to be composite insured. While co-insured can have various meanings, composite insured effectively insures two parties on a policy separately. This prevents one party invalidating the other’s cover. So if Mr and Mrs Smith are composite insured on their home insurance and if Mr Smith intentionally burns down the house, Mrs Smith can still claim under the policy.
- Non-vitiation: This is the protection against the policy validity being impaired by the action of another party. By securing composite insurance status such protection has already been provided.
- Subrogation: Zurich’s Anthony Wilson says requests for a ‘subrogation waiver’ demonstrates some of the problems with the letters brokers and insurers are receiving, as it shows a certain ignorance of the topic. If a lender is composite insured they are an insured party and cannot be subrogated against.
- Mortgagee in possession: This is when the banks take possession of the premises. Often banks seek to have no requirements on them until they are in possession of the premises and sometimes not even then. Anthony says, why would we allow this, they want us to protect their interest in the event of a loss but do not want to comply with the terms of the insurance.
There have been instances where the application of such requirements within loan agreements has been cited as being necessary because the banks are no longer able to rely on the ABI/BBA agreement to receive notice from insurers of changes that might affect their security. This, however, is misleading.
“Essentially, it got to the point where banks’ requests were not in line with the agreement that was in place, asking for onerous undertakings that went far beyond the scope of that agreement,” said Anthony Wilson Real Estate Senior Underwriter at Zurich Insurance.
The noting of interest on policies – the parameters of the previous agreement – offered limited safeguards for banks and as the new environment of tighter lending and much greater management of capital risk descended, it meant that banks were looking for greater protection on their loans.
“It is a business risk that the banks have identified and they are looking to pass that risk on to someone else, be it the borrower or, more commonly, their insurers,” said Anthony.
Notwithstanding that the new bank requirements go way beyond the historic position, the end of the ABI/BBA agreement has seen a flurry of composite insured requests by the banks on borrowers’ policies. Although, as Anthony explains, it isn’t quite as simple as just amending policies to meet this requirement.
“This is incredibly onerous for insurers because banks are requesting a number of things targeted at ensuring that, almost regardless of what happens, an insurer is unable to void a policy that is covering their interest in a property,” he said.
“In essence, there would be very few circumstances which could invalidate the policy but under the requests we are receiving, the insurer would still have to pay in respect of a bank’s interest.”
Composite insured means two parties on a policy are covered as if they were insured separately. No party can invalidate the policy in respect of the other. This is clearly a desirable position for a lender to reduce the risk of their security being damaged and not reinstated.
Receiving requests
The key problem for insurers and brokers is not necessarily that such requests are received when a property owner seeks finance, but that the lack of standardised terms means no two requests are the same. Being a complicated and onerous undertaking, the individual agreement of the precise content of each request is a time-consuming activity.
For example, letters may ask for confirmation that cover meets the requirements of the lender’s facility agreement, which the insurer or broker is not party to, and is therefore inappropriate for them to comment upon.
Another major issue is that requests are almost exclusively last minute and are critical for a bank to go through with funding. This means that negotiations need to be conducted in a truncated timeframe during what is for customers a very emotive time. This can create friction between customers and the insurer and advance warning could help ease the process of securing both lending and the required insurance cover.
Negotiating cover
Anthony adds: “Every time such a letter is received by a broker or insurer it needs to be reviewed in its entirety, and always has to be amended in some way, as there are frequently unacceptable items within the requests. The consequence is that brokers and insurers operating in the real estate market are spending an unbelievable amount of time just dealing with these issues.”
Zurich’s expertise-led approach, though, is fast becoming a real differentiator compared to many other carriers in the market in dealing with this issue.
“Insurers all have their own acceptability criteria, which varies from some insurers that won’t do it at all, through to insurers that will underwrite the risk and make a charge or adjust policies accordingly,” said Anthony. “We will look at each request and take an underwriting view. In the majority of cases, we will agree to the requests but there are times when we cannot.”
