Financiers use insurance policies as a means of protecting the loans they advance to borrowers and/or underlying assets which are offered as security. They use such products for risk transfer, but also for unfunded credit risk mitigation issues (eg, to address regulatory capital and asset risk weighting issues - in other words to reduce the cost of their capital and internal risk). Such products are used by financiers as insured parties themselves, or they accept such products as security offered by the borrower. This overview is intended to address the latter scenario where, as part of the security package, the borrower offers an insurance product.
Until the last decade, it was often the case that where insurance was required as part of the lending package, little attention was paid to the robustness or otherwise of an insurance policy (and the prospect of the insurance paying were a claim to arise). This lack of attention often resulted in financiers not being secured under these policies and, therefore, an increasing reticence to accept such policies or to attribute an appropriate weighting of such products as part of their security.
This state of affairs has changed, with products produced by insurers becoming increasingly aligned with financiers’ risks (and expectations) and, where applicable, have attempted to introduce the certainty (or a close approximation) which financiers would expect when comparing such a product with a guarantee (or a funded credit risk product).
Further, financiers increasingly scrutinise the insurance policies provided by borrowers to ensure they give the necessary protection and security in the event of the failure of the borrower to repay any loan, or the failure of the financiers to realise the underlying security.
However, there are a number of pitfalls which all parties should be aware when looking as to how such policies fit within the financiers’ risk/security matrix (and quite simple steps which can be taken to ensure that the financiers and, to an extent, the borrower can be protected).
Financiers Endorsement
First, unless there are compelling reasons to do otherwise, financiers should be co-insureds under the relevant policies which are obtained by the borrowers. The principal requirements for protecting the financiers’ interests are (a) for the financiers to be a named, or noted as additional, insureds under the borrower’s policy and (b) to ensure that the policy is a composite policy.
The means of effecting this outcome is for the insurance policy to include a “Financiers’ Endorsement” (which forms part of the policy wording) to make this explicit, ie, the insureds (including the financiers) are deemed to each have their own separate policies covering their own interests.
Limiting disclosures
However, there are a number of implications which arise when stipulating this state of affairs:
It follows in the usual course of events that if the financiers are an insured under the policy, they are required to disclose material information to the insurer (or, possibly, complete a proposal form). Financiers’ Endorsements will provide that the financiers have no duty of disclosure (and therefore the endorsement will include a waiver of disclosure and/or a non-vitiation clause which provides expressly that a policy defence with regard to other insureds cannot be employed with regard to the financiers).
Moreover, given that it is often the borrower which is required to obtain the policy and complete the proposal form it is, more often than not, the borrower which has the relevant information – why should the financiers be under any obligation of disclosure in this situation?
We would add that if there are instances where disclosure is required of the financiers, the impact of non-disclosure can be diminished by innocent non-disclosure clauses as well as limiting disclosure to specified individuals or departments (and such clauses are readily accepted in recently developed products).
Accordingly, if the basic requirements are observed then where the borrower commits an act which gives rise to a potential policy defence with regard to the insurer, such event will only impact the borrower which has caused the breach. Any remaining insured(s) will remain covered insofar as their interests exist independently of the borrower.
Party to claims
With regard to the administration of the policy, a Financiers’ Endorsement also provides for:
- the payment of premium, ie, it is the primary responsibility of the borrower, although the financiers can step in and pay the premium in extremis in order to protect their interests under the policy.
- destination of proceeds (ie, to the financiers).
- notification to the financiers of material changes. The Financiers’ Endorsement will provide that in the event of the cancellation or non-renewal of the policy they will be notified of such an event (it should be borne in mind that these endorsements place the onus on the insurer to make such notifications, although often the broker will be aware of this process and the borrower will have a contractual obligation to notify the financiers of these changes).
- the policy is to be considered a primary policy – if there are to be contributing policies then these should be addressed by the insurers between themselves (by way of contribution) once they have indemnified the borrower and/or financiers under the primary policy.
As noted above, financiers should not be noted as loss payees under the policy. The reason for this is that if the borrower is the sole insured under the policy and if a policy defence arises, the financiers will be in no better position than the borrower given that the policy would be avoided from the beginning. While a Financiers’ Endorsement does contain directions as to the payment of funds, it should not be seen as a substitute for the financiers being co-insureds under the policy.
Finally, where financiers take these policies “onto their balance sheets”, loss payee provisions will not assist in connection with the additional benefits identified at the outset – no regulatory capital benefit will be achieved absent a co-insured provision. Thus, if the financiers wish to avail themselves of the insurer’s balance sheet, the requirements of a Financiers’ Endorsement provides a viable and acceptable means of achieving this end (and a potential argument for the borrower to pay less for its borrowing!).
Mr John Barlow is a Partner at Holman Fenwick Willan Middle East LLP.