An exploration of the role that Contingent Property Insurance can play in covering a lender’s loss, in the event that a buildings insurance policy arranged by a borrower fails to respond to a claim.
With pressure increasing on budgets, a growing number of people are being forced to make difficult decisions about what they can and cannot afford. An estimated 25% of households do not purchase contents insurance1 and, as economic conditions worsen, buildings insurance could increasingly be seen as a non-essential spend.
Maintaining buildings insurance is a condition of any agreement related to securitised lending irrespective of whether a first or second charge is being established. However, it is unlikely to be feasible for a debt provider to verify that a policy is in place for every borrower. If a borrower fails to either insure their property or manage their insurance in accordance with the policy terms and conditions, it can leave the lender exposed if the property suffers major damage.
Even where a mortgagor does purchase an insurance policy, there are still instances, where the policy either won’t respond to a loss or the proceeds from the claim won’t be sufficient to rectify the damage. These would include failure by the mortgagor to declare a material fact when arranging insurance; the mortgagor failing to use the insurance proceeds for their intended purpose or under-insurance. The latter problem is becoming increasingly common in the face of a steep rise in construction costs.
The role of Contingent Property Insurance
Contingent property insurance provides protection for both first and second charge lenders in circumstances where the borrower’s insurance programme fails to respond. A slight variation on the policy deployed by lenders can also be applied in other scenarios where more than two parties have an insurable interest in a property, for example protection for investors in sale and leaseback deals where the lessor retains insuring responsibility after completion of the transaction.
How does it work?
Contingent property insurance is purchased to cover a portfolio of loans with the premium being calculated as a percentage (the Rate) of the total outstanding loan balance. The policy excess should be proportionate to the average outstanding loan amount whilst the limit should be aligned to the highest outstanding loan amount and should apply on Any One Claim basis.
In determining the Rate, insurers will want to understand:
- Loan type e.g., Mortgage, Bridging Loan etc.
- Total loan count
- Total loan value
- Average loan to value ratio
- Maximum loan value
- How many properties in receivership?
Deploying our combined understanding of insurance and risk management in both Real Estate and Financial Institutions, Aon can secure CPI insurance to cover contingent risks emerging from multiple forms of secured lending and, from sale and leaseback transactions. Our ability to identify new insurers has been particularly welcome as traditional providers of CPI have left the market.
A Life Insurer approached Aon for a quote for CPI after their incumbent broker presented a renewal premium that was significantly higher than the premium paid in the preceding year. The outstanding loan value totalled approximately £6bn and they required an any one claim limit of £3m. Aon negotiated a premium that was more than 50% cheaper than the quote provided by the other broker.
1 Source:  Association of British Insurers, reported in The Journal, Chartered Insurance Institute, June-July 2019
For further information, please contact:
Emma Vigus or Michael Chukwuma in Aon’s specialist Real Estate insurance team: