Lender’s insurance requirements: what borrowers need to know

In real estate finance transactions, lenders will seek to protect their interests in the property which secures the loan. One of the ways this is done is by ensuring the borrower has in place a comprehensive "all risk" insurance cover for the full reinstatement value of the property and that the lender’s interest is noted on the policy.

While the lender’s insurance requirements will vary on each transaction, understanding the range of insurance requirements is crucial to ensure borrowers comply with the lender’s requirements.

Our guide to insurance requirements helps to explain what lenders are asking for and how borrowers can ensure they adhere to these provisions.

• Noting interest
  Traditionally, it has been common practice for lenders to request their interest is noted on an insurance policy. However, solely noting an interest provides minimal protection for the lender since they will have no rights under the policy. Insurers will merely notify lenders if: a claim is made; a policy is cancelled or not renewed; a premium is not paid; or if cover is invalidated. Should the borrower invalidate the policy, the lender will be left without protection.

• Composite & Joint insured
  Composite insurance (or co-insured) provides lenders with their own separate right to make claims to the insurer which is independent of the borrower’s claims. Even if the borrower breaches the insurance terms (such as through fraud or non-disclosure), the lender can still seek compensation from the insurer. Composite insured differs from joint insured where both the borrower and lender are on the same policy. With joint insured, if there is a breach of the insurance terms, the insurer could void the entire policy, leaving the lender at risk. Composite insurance provides lenders with a more secure way to protect their interests.

• First loss payee
  If the lender is noted as the first loss payee on an insurance policy, it will receive the insurance proceeds instead of the insured party (save for any public liability or third party liability insurance). Typically, there is a monetary threshold specified to allow smaller claims to be paid directly to the insured borrower. The first loss payee alone will have no rights under the policy to pursue a claim against the insurer which is why it is common for lenders to request to be named both composite insured and first loss payee.

• Non-invalidation/non-vitiation
  A non-invalidation clause serves as an assurance that the lender will be granted a grace period during which it can decide whether to cover the insurance premium before the insurer cancels the policy. This provision comes into play if, for instance, the borrower defaults on a payment of the premium. This clause is also designed to safeguard each insured party from the policy being terminated or invalidated as a result of fraudulent activities, misrepresentation, or the failure to disclose information by another insured party.

• Waiver of Subrogation
  Typically, insurers may pursue a claim against an insured party or a tenant of the insured party to cover costs when either is responsible for the loss. A lender will want to include a waiver of subrogation in order to stop the insurer making the borrower’s financial position worse or jeopardising rental income, by seeking compensation from the borrower or the borrower’s tenant.

• Insurance Broker’s letter
  This is a letter from the insurance broker of the borrower, addressed to the lender, which sets out details of the insurance policies held by the borrower and confirms to the lender that the policies adhere to the insurance covenants in the finance documents.

If you have any questions in connection with lender's insurance requirements in a loan transaction, please get in touch with the Real Estate Finance team.