At a glance
- Zurich’s expertise-led approach in dealing with current lender requirements is proving a real differentiator
- Banks and insurers at loggerheads as banking sector attempts to de-risk their real estate activities and transfer risk into the insurance market
- Revised banking practices have seen a flurry of composite insured requests
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.
In addition, the recent ending of a decades-old agreement between the Association of British Insurers (ABI) and British Bankers’ Association (BBA) – which set agreed parameters for interaction between the two industries when a finance agreement was in place for a property – has muddied the waters somewhat again.
This 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
Since the financial crisis, the banking industry has been trying to de-risk real estate lending. But that risk did not disappear; it was merely being transferred to the insurance industry, by lenders requiring protections against shortfall or vitiation of insurances covering the loan security.
Misunderstanding the terms?
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.
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.
Zurich’s Colin Prince 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.
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 Colin Prince, Zurich’s Real Estate Deputy Underwriting Manager.
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 Colin.
Not withstanding 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 Colin 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, the insured could purposefully set fire to their property which, in normal circumstances, would 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.
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.
Insurers all have their own acceptability criteria. We will look at each request and take an underwriting view. In the majority of cases, we will agree to it
Colin Prince, Zurich’s Real Estate Deputy Underwriting Manager
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.
Colin added: “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, through to insurers that will underwrite the risk and make a charge or adjust policies accordingly,” said Colin. “We will look at each request and take an underwriting view. In the majority of cases, we will agree to it.”