Lenders often come to us with one clear question: “Does the insurance purchased by our borrowers properly cover our risk exposure?” While the question is simple, insurance coverage can be quite complicated.

There are multiple clauses and provisions in property insurance policies that are designed to include the lender’s insurable interest.  Some are similar in content, some are dramatically different.  The three main clauses are mortgagee, loss payee, and lender’s loss payee – but what do they all mean and when does each apply?

Mortgagee

What are mortgagees?:  Mortgagees are entities that have made a loan to a borrower in the form of a mortgage or deed of trust.  Mortgagees can be listed on borrower’s insurance policies if required by written contract. The mortgagee clause only applies to lenders of real estate or land.

When should this status be requested?:  This status should be requested on all loans where the lender has issued a mortgage or deed of trust.

Benefits/Drawbacks:  On most mortgagee endorsements, lenders are provided with a few key rights.  One right is to receive loss payment, even if the borrower invalidates the insurance contract.  For instance, if the borrower burns the property down on purpose, the borrower will no longer have right to loss payment, but the mortgagee will.  Mortgagees are also provided with 30 days’ notice of cancellation for any reason, except for 10 days’ notice of cancellation for reason of non-payment of premium.

Loss Payee

What are loss payees?: Loss payees can be mortgagees.  They can also be lessors and other financiers.  Loss payees lend against real estate, land, equipment or other personal property.  They can also be lessors that lease equipment or personal property to other businesses.

When should this status be requested?:  Loss payee endorsements often are very limited in nature, only providing basic rights.  As a result, it is not recommended to settle for this status on any policy.

Benefits/Drawbacks:  There are some benefits to being a loss payee, but there are also significant pitfalls.  The major pitfalls of this clause include: loss payees are not automatically notified if the policy cancels and the right to loss payment could be impaired by the insured’s negligent or wrongful acts that could invalidate the insurance policy.

Lender’s Loss Payee

What are lender’s loss payees?: Like loss payees, lender’s loss payees can be mortgagees as well as lessors and other financiers.  Lender’s loss payees can most often be the same types of entities as loss payees.

When should this status be requested?:  The lender or lessor should always request to be lender’s loss payee when entering into a mortgage, deed of trust, lease agreement, or other financing instrument with a borrower or lessee.

Benefits/Drawbacks:  The lender’s loss payee endorsement addresses most of the significant drawbacks of the loss payee endorsement.  This provides lenders of equipment or other personal property with a better option to make sure their interests are protected. Lender’s loss payees are provided with right to loss payment, even if the insurance is invalidated by the insured.  They are also provided with 30 days’ notice of cancellation for any reason, except for 10 days’ notice of cancellation for reason of non-payment of premium.

Lenders need to be careful when reviewing borrowers’ insurance policies.  Having the right coverage is important, but correct coverage does not matter if the insured can invalidate the lender’s/lessor’s ability to collect loss payment or if the policy cancels without notification being delivered.  Mortgagee, loss payee, and lender’s loss payee provisions can differ greatly from policy to policy.  As a result, it is important to review each one individually.

This post was written by Colin Ash, who is a Risk Analytics Consultant at Associated Insurance and Risk Management Advisors. Our Risk Management team works closely with lenders on contract reviews, insurance consulting, and loan reviews. Please reach out to cash2@associated.cc to learn more about how we can help.

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