A Better Hazard Insurance Policy is Yours for the Asking

Lenders taking a security interest in inventory, equipment or other goods know the importance of making sure that their collateral is insured and of having the lender designated as an additional insured on the borrower's hazard insurance policy. The manner of designating an additional insured can take several forms, each of which provide different rights to the lender, and, surprisingly, each of which generally is available at no additional cost to the insured or to the lender.

The lender's name should always appear in the "certificate holder" space on an insurance certificate. Without any further designation, the lender as merely a "certificate holder" is entitled only to notice from the insurance company prior to termination of the policy. As "certificate holder," the lender does not acquire any additional contractual rights, such as the right to obtain insurance proceeds, because it has not been named an additional insured.

A significant improvement over being named as certificate holder, and the most common form of lender coverage, is to name the lender as a loss payee or as an additional insured. Either designation entitles the lender to receive proceeds of the hazard insurance policy upon the occurrence of an insured loss, usually payable jointly with the borrower.

A lender named as loss payee may be adequately protected in most instances, wherein the lender will receive the proceeds and permit the borrower to replace the collateral or, in the alternative, to apply the proceeds toward satisfaction of the debt. Suppose, however, that the insurer objects to payment of the claim on the grounds that the borrower breached a condition of the policy, or even committed an intentional act such as arson that caused the insured loss. In this instance, the lender as loss payee or additional insured stands in the shoes of the borrower, and thus may be out of luck, having seen its collateral go up in smoke and being unable to recover from the insurer.

This last situation demonstrates the importance of the "lender loss payable" clause, which we strongly recommend that our lending clients require on all insurance policies insuring their collateral. The lender loss payable clause is similar to the standard mortgagee clause in a real estate hazard insurance policy. It protects the lender's right to collect its interest in the policy (that is, up to the amount of its loan) notwithstanding any defense that the insurance company may have against the borrower, for example, breach of contract or even intentional acts, such as arson. The lender loss payable clause in effect gives the lender a direct contractual right against the insurance company. Because the endorsement is available to lenders on equipment and inventory loans at no additional cost, there is no reason not to demand such coverage in connection with each such loan.

Similar coverage is available on a marine or aircraft policy in the form of a breach of warranty rider. This rider normally does, however, result in an additional premium. Due to the significant conditions and limitations placed upon the operation of aircraft, vessels and other items insured by marine or aircraft policies, a breach of the insurance policy is more likely to occur than in the case of a general equipment or inventory policy, thus requiring the borrower to pay the additional premium to obtain breach of warranty coverage is a sound business decision.

Assignment of Life Insurance Policy as Collateral.

While on the topic of insurance, we thought we would point out one issue with respect to assignments of life insurance that sometimes appears to be misunderstood. Because the Uniform Commercial Code does not apply to insurance policies, and because an insurance policy is not a negotiable instrument, an original insurance policy document does not hold any special significance with respect to perfection of a security interest in the policy. A lender's security interest in an insurance policy may only be perfected by obtaining the acknowledgement of the issuing company to the assignment. As a result, extending credit to a borrower that has produced the original insurance policy can present risk if inquiry of the insurance company has not been made prior to disbursing the loan. A prudent lender must ascertain first that the policy has not been canceled, and then must make certain that no prior assignments of the policy are on record with the insurer. Although it often takes weeks to receive an acknowledged assignment from an insurance company, we have found that it is quite easy to obtain confirmation of the status of the policy within a day or two, and we recommend that such inquiry be made whenever taking a life insurance policy as collateral.