What a difference one word makes
A loss payable provision and lender's loss payable are not interchangeable
By Donald S. Malecki, CPCU
Two terms that are well understood in insurance circles are (1) mortgagee provision and (2) loss payee or loss payable provision. The first term is used with reference to real estate property and is a necessary provision when a financial institution lends money to the purchaser of real estate. The second term is understood to be a document required by lenders as security for the purchase of personal property, and by owners of equipment leased to others.
Both terms have been around for decades. Yet, if a lender were to request that the borrower’s property insurance be amended with the issuance of a lenders loss payable provision, chances are that the loss payee or loss payable provision would be issued instead. If this occurs, the reason is likely to be that, from the insurance person’s frame of reference, the term, lender’s loss payable provision, is the equivalent of a loss payable provision.
To the contrary, however, there is a significant difference between a loss payable, and a lender’s loss payable provision. When a loss payable provision is issued by an insurer as proof of security for a loan or a lease on personal property, insurance on the lender’s or owner’s insurable interests can be invalidated by any act of the borrower or lessee of the property. However, with the lender’s loss payable provision, insurance on the lender’s interests is not invalidated by the acts of the borrower.
Assume, for example, a person borrows money from a financing institution in order to purchase some office furniture. As part of the deal, the purchaser agrees to a lien being placed on the office furniture as security for the loan.
Later on, fire extensively damages the office and its furniture under suspicious circumstances. An investigation reveals that the borrower may have caused the fire in order to defraud the insurer. If the insurer has good grounds for denying coverage, the lender’s interests in such property also are in jeopardy. In fact, if the insurer denies coverage to its named insured, the insurer is also on safe ground to deny coverage to the lender.
Cases are legion where financial institutions have been denied coverage by insurers when autos of borrowers are intentionally destroyed so as to defraud the insurers.
Case in point
In a recent case, a manufacturer borrowed in excess of $2 million to purchase additional inventory and granted the bank a security interest in its inventory. The bank lent the money and filed a lien on the inventory that was purchased, subject to certain conditions, including that it be named as a lender’s loss payable.
The manufacturer sent a written notice of insurance requirements to its agent, which required the property policy be written on an all-risks basis, for the full insurable value, for replacement cost, with a Lenders Loss Payable clause and the stipulation that the insurance will not be cancelled or diminished without a minimum of 30 days’ notice.
There is some dispute whether the agent sent this same written insurance request to the managing general agent of the insurer. When the policy was issued, however, the bank was shown as a loss payee, rather than as a lender’s loss payee. It may have been that the agent did not send this written insurance request on to the MGA and simply communicated that the bank was to be listed as a loss payee.
What seems to confirm this fact is that the agent, although not authorized to do so, issued an ACORD Evidence of Property Insurance (now titled Evidence of Commercial Property Insurance) showing that the bank, as a certificate holder, was named “contents loss payee as their interest may appear.”
Another point which indicates that the MGA may not have received notice is that there would be no reason for the MGA, as the insurer’s representative, to have denied issuance of a lender’s loss payable provision, had it received a request to do so. In fact, no underwriting is involved, nor is an extra charge made, for issuing a loss payee or a lender’s loss payable provision.
Interestingly, what was stated on the certificate was a proper description of the bank’s covered interest as a loss payee. Unfortunately, the bank representative who was supposed to have checked these certificates, did not pick up on the fact that the certificate did not confirm a lender’s loss payable status. One probable reason is that some bankers also are confused between a loss payable provision and a lender’s loss payable provision.
Unfortunately, it turned out that the manufacturer defaulted on its loan and vacated the premises. As a result, the bank filed a claim with the manufacturer’s property insurer, which was denied because of the allegedly dishonest act of the manufacturer. As explained by the insurer, with the bank’s status as a loss payee, its coverage was invalidated by the act of the named insured. Without another recourse of its loss, the bank’s target for suit was the agent.
Short of being the recipient of a written request by a financial institution to add a lender’s loss payable provision, the agent or broker is in no position to inquire whether that provision is necessary. The primary reason is that the Property Section of the ACORD application does not even request a lender’s loss payable status. What it does list is the status as a loss payee or mortgagee. How, therefore, would an agent or broker even know if someone wants to be covered under a lender’s loss payable provision?
It is also important to point out that the ACORD Additional Interest Form 45 (2003/04), which is used to confirm interests in real and personal property, does not list the lender’s loss payee as an option. Those listed are: additional insured; loss payee; mortgagee; lienholder; and employee as lessor.
What all of this means, in no uncertain terms, is that the burden for the proper selection of coverage is on the financial institution or the owner of equipment to be leased to others.
What also complicates matters here for lenders is that the ACORD Evidence of Commercial Property Insurance does not list the lender’s loss payable status. It lists only the status as loss payee and mortgagee. So when the Evidence of Commercial Property Insurance is issued by the authorized representative and loss payee is shown as the status, it would behoove the certificate holder, who has requested lender’s loss payable status, to inquire about proper coverage. Otherwise, it may fall short of what is expected.
In the default loss described above, if a written insurance request had not been given to the borrower’s insurance agent, the entire blame could have been shifted to the lending institution, since it had fair warning based on the correct description of the certificate that it was a contents loss payee. However, such was not the case.
The moral of this story is that agents and brokers need to be careful that written requests for lender’s loss payable status are transmitted to the underwriters. Lenders and lessors of equipment also have no right to believe that they are properly protected on borrowers’ property policies, in the absence of specific directions to be so named or listed.
The current ISO endorsement used to designate the appropriate lienholder’s interest for personal property is Loss Payable Provisions CP 12 18 06 95. It lists the following options that need to be checked with the issuance of this endorsement. (1) Loss Payable, (2) Lender’s Loss Payable and (3) Contract of Sale.
When the lender’s loss payable provision is designated, it is confirmed that the loss payee shown in the Schedule or Policy Declarations is “a creditor, including a mortgageholder or trustee whose interest in Covered Property is established by such written instruments as Warehouse Receipts; Contract for Deed; Bills of Lading; Financing Statements; or Mortgages, deeds of trust or security agreements.”
The ISO endorsement that preceded this current one, CP 12 18 10 90, is somewhat different with regard to the Lender’s Loss Payable provision. It states that the loss payee shown in the Schedule or Policy Declarations is “a creditor (including a mortgageholder or trustee) with whom you have entered a contract for the sale of Covered Property, whose interest in Covered Property is established by such written instruments as Warehouse Receipts; Contract for Deed; Bills of Lading; or Financing Statements.”
This earlier endorsement’s provi-sion is pointed out for two reasons:
First, the underlined phrase no longer appears in the latest provision of Lender’s Loss Payable, and there appears to be no written explanation for its removal.
Second, some insurers may still be using this earlier endorsement containing that underlined phrase. In fact, this was the endorsement that was issued in conjunction with the above case involving the manufacturer. Had the Lender’s Loss Payable provision been selected, instead of the Loss Payee provision, the bank’s protection still could have been denied, because the manufacturer (you) did not enter into a contract for the sale of Covered Property, but instead for the purchase of Covered Property.
The American Association of Insurance Services (AAIS) has a similar endorsement available titled Loss Payable Options CP-132, Ed 1.0. Its schedule is similar to that of ISO, requiring a description of the property and the loss payee’s name and address.
The AAIS endorsement, however, does not explain what is necessary to establish an interest in covered property—i.e., warehouse receipts, contract for deed, etc. It does clearly state, however, that insurance continues for the loss payee even when the named insured’s insurance may be void, because of the named insured’s acts, neglect or failure to comply with the coverage terms.
The term “loss payee” is too commonly bandied about by lawyers, courts and others as some all-encom-passing term denoting a person’s or entity’s interest in property. It also is confusing among financial institutions and insurance people.
Part of the reason may be that this term has been in existence long before the term, lender’s loss payable. In fact, what really makes matters treacherous is that there is a distinct difference between lender’s loss payable and a loss payable provision.
The lender’s loss payable provision unquestionably is the better of the two, because insurance on the lender’s interests is not invalidated by the acts of the borrower. Given this distinct advantage, one wonders why the loss payable (or loss payee) provision even exists—unless laws of states or insurance codes still mandate its use for certain personal property, such as automobile financing arrangements.
The burden of determining whether the proper coverage is provided should fall on the lender or lessor of personal property who is seeking coverage. Unfortunately, since the Evidence of Commercial Property Insurance does not list “lender’s loss payable” as an option, it might be a good idea for the lender or lessor seeking coverage to also obtain a copy of the appropriate endorsement. (This is the same approach of entities desiring to confirm their additional insured status in conjunction with insurance certificates.)
Agents or brokers need to transmit written lender’s loss payable requests directly to the insurers and confirm proper issuance. In the absence of such specific, written request, or if a specific request is made for loss payee status, which is not uncommon, the agent or broker is well within its rights to request that status instead, whether or not it turns out to be the incorrect designation. *
Donald S. Malecki, CPCU, has spent 45 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates L.L.C., an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.