Page 36

CREFW-Fall2014 10.15.14

“Much Ado” About Insurance Requirements: When Loan Originators Think Like Insurance Underwriters, We All Sleep Better at Night Jon Kemp fter a loan has been originated and the lender’s servicing operation begins their work, there is often anxiety about whether the insurance required at closing is appropriate for the hazard risks inherent to that property type, and whether the limits of liability selected for the insurance requirements are sufficient to fully protect the collateral in the event of a loss. This anxiety can be mitigated, and in some cases eliminated, if the originator analyzes the hazard risk in the manner employed by insurance agents and underwriters. The originator should keep the following points in the forefront of his/her mind when deciding what types of insurance and what limits of liability are consistent with how an insurance underwriter views the risk: 1. The insurance requirements should be based on the property’s exposure to loss. What perils (e.g., flood, windstorm, and earthquake) are likely to cause damage to the property based on where it is located? If the building was built before the area’s most recent catastrophe (e.g., windstorm or earthquake), does it comply with current building codes or is there a significant ordinance or law insurance exposure? 2. Insurance limits should be based on the property’s insurable replacement cost or in the case of liability exposures, the loss history for similarly situated buildings. 3. Lenders, servicers, insurance agents, and insurers all have a stake in assuring that our mutual customer (for lenders and servicers it’s the “borrower, for insurance agents it’s the “client,” and for insurers it’s the “policyholder”) has insurance in force that is adequate to restore a property to its pre-loss condition or to protect the customer from an uninsured liability loss that could cause financial ruin and a default under the existing loan. Insurance Exposures As Stephen Dedalus, the protagonist in James Joyce’s “A Portrait of the Artist as a Young Man” said, “I go to encounter for the millionth time the reality of experience and to forge in the smithy of my soul the uncreated conscience of my race.” In a similar manner, an insurance agent analyzes a property and his/her job is to identify the myriad of known loss exposures, imagine the previously unknown loss exposures that could affect a property, and work with the underwriter to design an insurance policy to address CRE Finance World Autumn 2014 34 those exposures. The art of identifying loss exposures is the key first step to successfully applying a hazard risk-based method of developing insurance requirements for loan documents. Accordingly, an originator should apply the same principles when making the determination as to which perils should be insured against by the customer for a particular loan and make sure those perils are part of the insurance requirements for that loan. For example, if the subject property is in a low-lying coastal area prone to hurricanes and windstorm risk, the originator should verify whether the property is in a flood zone and, if so, insist that the borrower provide flood insurance and named windstorm coverage as part of the insurance requirements (since flood exposures and hurricane exposures are normally excluded from policies unless added by endorsement). As we witnessed during Superstorm Sandy in 2012, properties in these locations have a significant probability of being damaged by wind forces, as well as surface water (storm surge), which can flood the premises during the storm. As the customer has both types of coverage in place, there should be no ensuing argument with the insurer over which peril caused the loss, since both perils are covered under the policy. Another situation that arises periodically is hazard-risk exposure that is less obvious in nature. In parts of the country where there are older buildings built prior to the most recent amendments to local building codes, there is a potential that some or the majority of property will not be covered by the policy if an ordinance or law coverage endorsement is not added to the policy. Accordingly, loan originators will need to do a thorough review of the appraisal or inspection report to determine if there are any non-conforming conditions present in the building. Local building ordinances often have a threshold of damage for properties where if the property is damaged to an extent at or above the threshold (typically 50% or more), the building must be reconstructed in accordance with current building codes. Standard property insurance forms (e.g., ISO CP 10 30) state “We will pay for direct physical loss of or damage to Covered Property at the premises described in the Declarations caused by or resulting from any Covered Cause of Loss.” Loan documents typically require the ‘Special Form Cause of Loss’ that defines Covered Causes of Loss as follows: A Director, Insurance & Risk Management Wells Fargo Commercial Mortgage Servicing


CREFW-Fall2014 10.15.14
To see the actual publication please follow the link above