This Is Part II of III
Parts I, II, & III in Total
Insurance relating to insuring real property:
Real property ownership usually requires Insurance and, in most cases, multiple coverages, mainly when a lender finances the property. Part I provided a general overview of Insurance, while Parts II and III covered overviews of real estate-related insurance and lenders’ requirements.
Understanding the technical terms used in Insurance, such as coverages, exclusions, endorsements, and adequate amounts. The insurance industry has specialized jargon; mastering it over time will empower you with the knowledge needed to make informed decisions about your real property insurance.
Types of coverage will be summarized at the end of part III.
Determining the correct amount of Insurance involves meeting the lender’s requirements and assuming responsibility for potential risks. It’s a proactive step in protecting your real property.
There are different definitions of value. Market Value refers to the value of the property bought and sold in a competitive marketplace. This value is crucial, as it can significantly impact the cost of your Insurance. The legal definition of market value is the price at which the seller is willing but not compelled to sell and would accept from a buyer who is willing but not compelled to buy. Establishing an opinion of value, commonly referred to as market value, is determined by comparing the market prices of comparable properties in neighborhoods with similar amenities.
Insurable value, which reflects the replacement cost of the buildings and appurtenant structures, is critical in real property insurance. This value is what your insurance policy will cover in the event of a loss, and understanding and accurately determining this value will give you a sense of security, knowing your property is protected against potential risks.
The appraiser plays a crucial role in determining the insurable value. Their job is to segregate the improvements from the value of the land property and determine replacement costs, including outbuildings and appurtenances. Tappraiser’s appraisal report is used to determine the amount of Insurance, and they will apply a depreciation factor and perhaps an economic obsolescence factor to create an overall value. This provides you with a reliable and accurate assessment, giving you a sense of security and confidence in your insurance decisions.
The land value component varies significantly with geographic location and desirability. A structure with an ocean, lake, mountain, city, park, or amenity-based frontage may result in a high premium for the land component. The property is assumed to be pleasant, attractive, and agreeable, which results in greater demand. However, the replacement cost of most of the structure may be the same regardless of the land value.
If the loan exceeds the replacement cost of the building, the land is likely to be more significant as a proportion of the overall value. A Borrower should discuss the amount and types of Insurance with their agent/broker to determine what is correct and acceptable to the lender.
Although liability insurance is not required, borrowers should have coverage of at least one million dollars. Five million is preferred because the premium is not significantly more. In the U.S., litigation, jealousy, envy, and hatred have become recreational activities. Liability coverage is essential for insuring residential rentals and commercial structures, such as retail spaces with rental or leased fees. If the property is a residential structure, the liability portion of the coverage is an insurance rider referred to as an umbrella policy.
Additional insurance coverage may be necessary, depending on the property’s type and intended use. These coverages can be included in the primary insurance policy or may require a special endorsement, adding to the complexity of insurance decisions. However, being cautious and prepared for all possibilities will give you a sense of security and peace of mind, knowing you are adequately covered.
A few questions to be answered:
- Understanding who the primary insured parties are is crucial in the insurance industry. Similarly, including secondary or additional insured parties in the policy is a responsible step to avoid misunderstandings. This understanding will make you feel informed and accountable in your insurance decisions.
- Are there secondary or additional insured parties?
- Are there insurance considerations, such as Insurance that property owners require of tenants or lessees, covering various losses and liabilities that are not or should not be the property owner’s responsibility?
- Are additional types of Insurance required to cover furniture, fixtures, and equipment, loss of rent, business interruption, employee theft, loss of intellectual property, use of an employee or vendor vehicle not belonging to the insured party, workers’ compensation, and liability?
Policy exclusions:
Carriers have different exclusions and what they will cover by separate policies and add-on endorsements. Most insurance carriers have policy exclusions including but not limited to ordinance or law, tsunamis, floods, drain & and sewer backups, seeping groundwater, standing water, mold, total pollution exclusion, asbestos, lead-based paint, earthquake, earth movement, acts of war, mold/mildew & fungus, acts of war, nuclear, biological, chemical, acts of terrorism, etc.
Insurance does not cover damage due to poor maintenance or quality, general wear and tear, pest infestations, power failure, nuclear hazards, government actions, intentional loss by the insured, and home-based business liability unless specific endorsements are purchased.
Coinsurance provisions:
Many insurance policies for both residential and commercial properties have language referred to as covering the coinsurance provision issue of under-insurance. A coinsurance clause requires that policyholders insure their property for a reasonable replacement cost. The insurer will receive a fair premium for the risk it assumes. A coinsurance clause will require policyholders to guarantee up to 80, 90, or 100% of the replacement cost for the structure(s) and appurtenant(s).
Coinsurance penalties will be applied to claims for underinsurance and vary according to the company and policy type. Effectively, a coinsurance penalty triggers a contractual requirement that the insured party pay a portion of their financial loss using a calculation formula in the policy. Some insurance companies offer step-up coverage endorsements to reflect higher replacement costs resulting from inflation.
If a policy contains a coinsurance penalty provision, a claim may result in an underinsured claim. The insurance company will pay up to the policy limits and leave the underinsured party responsible for the remainder of the costs. The insured party may be required to pay for a portion of the loss. Their portion is part of their reconstruction cost, including betterments and enhancements.
Underinsurance is more prevalent now than before due to the upward cost pressure caused by inflationary increases in construction costs. For example, lumber prices, other materials, and labor have increased dramatically. Municipal approvals and building standards/codes are much more stringent. Add-on municipal fees (taxes) have gone up.
A mortgage broker, Borrower, or insurance provider who calculated $200 per square foot a few years ago may find that the replacement cost has doubled to $400 per square foot, including the land value. Housing replacement costs may range from $200 per square foot for entry-level production homes to $1,000 to $2,000 per square foot for high-end custom homes.
Lenders and mortgage companies may want to audit their loan portfolios to ensure that property coverage adequately offsets inflation. They may also discuss methods and data sources for calculating replacement costs. Most insurers and appraisers use Marshall & Swift cost estimator data to estimate construction costs.
Forced order insurance coverage:
If borrowers fail to pay their premiums promptly or default, the loan servicer will require the Borrower to pay the current premium.
Example notice mailed to the Borrower:
Loan Number:
Property:
Amount of coverage:
Amount of premium:
Dear Borrower:
Since you have not provided the required proof of Insurance, the loan servicer purchased Insurance on your behalf on the loan mentioned above under the terms provided in your loan documents.
The policy cost must be paid in full, including accrued interest and your regular payment. This interim policy is only suitable for 60 days.
To avoid further default on your loan, you must replace this temporary Insurance with a permanent policy within the 60-day time frame above. Failure to do so may result in foreclosure proceedings being started, and a Forced Order Policy will be purchased to protect the beneficiary’s interest at a considerably higher cost than the policy you can buy.
Please be aware that this POLICY COVERS THE REAL PROPERTY ONLY; IT DOES NOT PROVIDE YOU WITH LIABILITY COVERAGE, THEFT, OR ANY COVERAGE RELATING TO YOUR HOUSEHOLD. IT IS
If you have any questions about this notice, please contact us immediately after receiving this communication. Time is of the essence.
Sincerely,
Loan Servicer
Forced order in servicing is also known as forced-placed or lender-placed Insurance.
Federal Law Restricts Force-Placed Insurance.
Before purchasing a force-placed insurance policy, the Servicer must reasonably believe that the Borrower has failed to maintain insurance coverage. Verification is usually done by calling the insurance service provider or broker.
If the Borrower's insurance agent or insurance service contacts the Servicer to inform them that the bill is overdue, that would be greatly appreciated. The Servicer will have a reasonable time to send notice to the Borrower.
The Servicer must send two notices to the Borrower for placing force-placed Insurance. The notices must request that:
The Borrower obtains hazard insurance for the property and
Submit the Insurance to the Servicer, such as a copy of the insurance policy declaration page, an insurance Certificate, or the policy.
Timing of the Required Notices:
The Servicer must send the first notice at least 45 days before placing a force-placed insurance policy. The Servicer must send a second reminder notice at least 15 days before charging the Borrower for force-placed insurance coverage, but no earlier than 30 days after the first notice. This notice must include the cost of the force-placed Insurance or a reasonable estimate. (12 C.F.R. 1024.37).
The Servicer will generally advance funds to the existing policy to maintain insurance coverage on the property. The Servicer can cease a forced order if desired. The property is vacant; therefore, Section 1024.17 of the 12 C.F.R. applies.
When the Borrower provides proof of Insurance coverage, the Servicer will:
Cancel the force-placed Insurance within 15 days of receiving evidence of existing Insurance.
Refund any premiums necessary to avoid duplicate coverage (12 C.F.R. 1024.37).