Peter Morse explains what a “co-insured” clause means in insurance policies
As lenders become more risk-averse, banks, building societies and finance houses are increasingly seeking to protect their investment in property. One method is the “co-insured or composite insured” clause in insurance policies (sometimes referred to as a lenders’ or mortgagee protection clause), which, in addition to the first charge on the property, gives the lender the first charge over the insurance policy.
What are the implications of this for landlords and property owners?
Security
Lenders like to see insurance in place for a secured property and evidence of it is normally a condition of the loan agreement. They also want to know that the property remains covered during the life of the loan. This is usually achieved through a covenant to maintain satisfactory insurance and to notify it of claims.
There are two ways of giving lenders the protection that they need. Standard property-owners’ insurance is the most common, supported by the type of agreements and notifications mentioned above, and then there is the co-insured clause.
Lenders are increasingly taking the co-insured route because it allows them to tighten their terms of lending. It means that the lender not only has a right to be notified of a claim but is in effect the insured party. Regardless of what the borrower does in relation to the policy – for example, breaching the terms and conditions – the policy continues for the benefit of the lender. This is achieved through a “subrogation waiver” in favour of the lender in the co-insured clause. It also provides for the lender to be made first payee and given sole discharge in the settlement of a claim.
The property owner should be alert to the implications of what they are signing: for example, claim settlement, which can be either reinstatement or cash. If the insurer opts to settle in cash and the bank accepts this, the landlord would be left with no option to reinstate the asset unless the bank put money towards this. As bank lending requirements become more stringent, many landlords are losing sight of the fact that they no longer have the benefit of their own insurance policy, despite having paid the premium.
Smaller claims generally aren’t problematic because the “first loss payee clause” will normally have a limit written in. This typically ranges from £50,000 to £250,000, depending on the size of the property. It means that a claim below the limit can be dealt with by the policyholder directly with normal notification to the lender. However, for larger losses, the property owner has signed away all powers of decision making.
Protection
It is the broker’s responsibility to clarify for property owners the risks inherent in co-insured. If the lender isn’t persuaded to go down another route, it is important that the insurance policy contains, at the very least, a right to reinstate agreement. The highest limits (£100,000 to £250,000) should also be sought in relation to the first loss payee clause. It’s also important to keep a light touch in relation to compliance with the policy terms by simplifying the wording, particularly in relation to requirements to notify the lender of policy adjustments.
Some insurers understandably increase their rates to provide the extension of cover inherent in the non-vitiation clause – the extra cost being effectively a further charge on the loan to the property owner. Many insurers also sign legal agreements tying them to service promises they make to the lenders, which means that if landlords and property owners want to change insurers they will have to obtain the lender’s permission. The scenario outlined illustrates some of the problems inherent in switching these contracts.
A bank insists that insurer X includes a co-insured clause in covering a group of mortgaged properties owned by landlords, ABC Group.
On renewal, insurer X increases the rate on the policy but the broker discovers that a saving of £3,000 can be made by switching to insurer Y. On further investigation, however, it becomes apparent that the legal fees required to draw up another agreement would exceed £5,000. It is also suggested by the lender that by switching insurers they might prejudice the original agreement. ABC Group is left with no freedom to switch and consequently higher costs.
Points to note
No co-insured policy should be entered into without the property owner’s legal advisers confirming that the insurance arrangements do not contravene the conditions of the fully insuring and repairing lease, particularly in the area of reinstatement of the property. For example, the signing of a lease can significantly expose the landlord: the two contracts are separate, just because the benefit is paid to the lender, does not absolve the landlord of its responsibility to reinstate the premises under the terms of a lease. Another implication where the co-insured does not sit comfortably with a lease is that the landlord is obliged to arrange insurance on behalf of the tenant at a fair market price. If, say, three quotes are obtained and the holding insurer is well above the other two, it could be considered that the landlord is stuck with a more expensive insurer and thus in contravention of lease obligations.
It is important to note that insurers will not pay indemnity twice: a payment to one insured party (ie the lender) is held to be a payment to all insured parties. This is an important consideration, because if a leaseholder incurs cost in the event of a loss because they are responsible under the lease and subsequently attempts to recover these costs under the policy, they may not be paid if indemnity has already been provided to the lender. Large asset owners need to be aware of this.
It is not uncommon for lenders to require a freeholder’s intermediary to agree to a non-standard process or notification. This has an operational effect on brokers of having to notify lenders in the event of a claim, cancellation or even change of cover.
The rapid growth in co-insured arrangements will cause increased friction between lenders and borrowers and a detriment to many borrowers’ businesses by compromising their ability to plan and budget. In the long term, the onus is on the insurance industry to produce a standard form of policy that protects the rights of both parties. Until then, property owners will have to rely on the vigilance of their brokers and their legal team.
Peter Morse is executive director at specialist property broker Clear Insurance
