5 Things You Need to Know About Lender Requirements

By Kevin Smith, Vice President of the Real Estate Division, The Graham Company

Kevin Smith, vice president, Real Estate Division, the Graham Company

When purchasing or refinancing a commercial or multifamily real estate property, buyers are required by lenders to secure insurance coverage that meets minimum standards. The minimum requirements set by lenders are often just that – the minimum coverage you should seek to protect your property. Here are five major considerations to help you determine if lender insurance requirements are adequate enough protection for your real estate investment.

In almost every case, lenders require the following basic standards be met for an insurance program:

• Insurance companies must be in good financial standing (A.M. Best rating of at least an A with a financial size of $50-$100 million in policyholder surplus)
• Proof of insurance (Certificate of insurance or copy of policy)
• Notice of cancellation within 30-60 days if the policy is canceled.

Individual vs. master policy approach

Property owners can take an individual or master policy approach for property insurance. A master policy, typically for portfolios with more than $50 million in insured values, provides coverage across your portfolio and takes advantage of greater purchasing power and geographic spread of risk often with broader coverage.

Under a master policy, lenders will require you to provide evidence of sufficient limits covering your entire portfolio inclusive of the property they have an interest in. If there are no lender requirements regarding whether an individual or master policy is acceptable it is recommended that you confirm what they will accept and the means to satisfy requirements.    

Adding specific provisions

Lenders also will look for specific provisions within the property coverage, such as replacement cost coverage; loss of rent coverage; coinsurance percentages; terrorism coverage; equipment breakdown; ordinance or law coverage; and deductibles. Evacuation and relocation expenses are usually not required by lenders, but can provide needed additional funds after a loss. Lenders differ on some coverages and limits required, but all are important components of a property policy that should be specifically addressed according to your exposure and appetite for risk.

Adjusting deductible levels

Lenders will typically require a $10,000 or $25,000 deductible. Depending on your appetite for risk, you may be able to take on additional risk within your program and, in doing so, exceptions will need to be sought from the lender. A common solution is to have a larger deductible on the policy and negotiate an indemnification provision whereby the insurance will allow you to evidence a lower deductible to satisfy lender requirements.

Entering into this type of arrangement requires deep analysis of your loss experience, but if losses are low there is the opportunity for lower ultimate costs.

Model property for catastrophic perils

There may be very specific requirements for catastrophic perils if the property is in an area prone to natural disasters. Regardless of the lender requirements, your properties in these areas should be modeled to determine the probable maximum loss you are exposed to from any single catastrophic loss and the coverage should be structured accordingly.

Enhanced liability coverage

Lenders will require that policies include them as an additional insured under your policy to cover them from lawsuits resulting from property damage or bodily injury to others and specific Excess limits depending on the size and use of the building, which oftentimes will require an umbrella or excess policy. While basic liability coverage typically will satisfy lender requirements there are many areas where enhanced coverage can provide additional protection. Some examples include separate limits per location, hired or non-owned automobile liability coverage and broadened contractual liability. In addition, it is important to consider, many insurance companies are specifically looking only to cover the lessors’ risk for that location. In the event you perform any construction activities at the location, coverage should be contemplated under your polices, as well.

Final thoughts

By ensuring your properties are well maintained and mitigating loss wherever possible, you will improve the risk profile of your locations, thus reducing the long-term cost of insurance. Some additional considerations worth contemplating include periodic loss control inspections, proper maintenance of equipment and mechanical systems, and programs focused on mitigating hazards.

Kevin Smith is vice president of the Real Estate Division at The Graham Company, one of the Mid-Atlantic region’s largest insurance brokerages. Contact him at [email protected] or 215.701.5323