Lenders’ insurance requirements – Our solutions to new challenges

lenders due diligence
Shifting market conditions, an insurer drive to mitigate exposures and an increased focus on the content and intent of policy wordings all mean that procuring agreement from insurers to lenders’ insurance requirements is becoming increasingly challenging in real estate transactions. As a consequence, the role of the insurance broker is more critical than ever to the successful and timely navigation and implementation of these requirements.

The origin of lender insurance requirements as we currently know them, typically as detailed in The Loan Market Association recommended form of facility agreement, can be traced back to 2012. It was on the 31 December 2012 that the Association of British Insurers (ABI) formally withdrew from an agreement with the British Banking Association (that had been in place since 1992), which allowed for lenders to inform insurers of their interest in borrowers' properties. Insurers agreed, in turn, to notify the lender of certain changes to the policy terms, conditions, and cover and provide notification of cancellation requests. The agreement also afforded lenders a defined period in which to arrange their own insurance policy in the event that the borrower failed to maintain cover in accordance with the requirements of the facility agreement. 
With the termination of the agreement and associated exposure to the security for the loans came a significant change in the insurance obligations of the borrower, as stipulated in the facility agreements by lenders. More onerous provisions become prevalent, with increased requirements for the borrower and the insurer. 
Attempts to standardise these requirements have met with some success, and most insurers will now agree that their obligation is to note the lender as composite insured and first loss payee. They will also typically agree that the lender will have no liability to the pay the premium (unless they choose to, such as to avoid cancellation of cover), a subrogation waiver, and no duty of disclosure unless the lender becomes mortgagee in possession.
However in recent years, insurers have become increasingly sensitive to the additional burdens that such clauses place on them and indeed, the fact that some of the clauses are contrary to existing policy terms.  For example, the facility agreement requirement for insurers to give 30 days’ notice if it proposes to cancel the policy is problematic in that there will be instances, especially in the case of material non-disclosures, where insurers would expect to cancel the policy with immediate effect.
In consequence, insurers are more reluctant to agree these requirements in their original form or in some instances at all, making it even more challenging for brokers and borrowers' to achieve compliance with the facility agreement requirements. 
The key here, is that these obligations and the specific form of words the facility agreement requires in each case are not standard to a typical real estate insurance contract. This means that bespoke inclusions/amendments to the policy wording must be negotiated with the insurer by the broker on a case by case basis.  
The result is extended negotiations between insurers, brokers, and lenders on the form of words to be used, bringing an increased risk of delayed transactions and potentially greater costs incurred by all parties. Hard market conditions and a greater focus on policy wordings (accelerated by the onset of the pandemic) are only leading to further fragmentation and divergence in the approach to lender insurance requirements among real estate insurers. 
While it is still possible to achieve policy compliance with the LMA facility agreement insurance provisions, modifications to the notice of cancellation, non-invalidation/non-vitiation and first loss payee wordings in particular are becoming more frequent, with insurers now seeking to limit their obligations and write out provisions that will prove difficult to comply with or are contradictory to the policy terms.
For both borrowers and brokers, who are frequently required to provide a letter with reliance to the lender confirming policy compliance with the insurance requirements in the facility agreement, this divergence between what insurers are prepared to agree and the drafting of the facility agreement is becoming increasingly challenging to reconcile.
Until such time that lenders and insurers can agree revised standards (which is unlikely to be imminent due to the challenges in reaching a consensus here), the best mitigation is to work with a well-informed and proactive broker that has an appreciation of what insurers are prepared to agree. Early engagement between the lender, broker, and borrower over the drafting of the facility agreement is also advised.
Our approach as a Due Diligence practice is to continue where possible to use our knowledge and experience to negotiate the best practice requirements in line with the current LMA provisions. However, where deviations are necessary, we provide clear advice on the practical impact of these changes to enable lenders to make informed decisions on their facilities. 
If you are a lender that would like support from our experienced and proactive Due Diligence team on facility agreement drafting and the compliance of borrower insurance policies with the insurance provisions of the facility agreement, please do not hesitate to get in touch. 

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