For as long as there have been insurance
policies consumers have complained about the difficulty in reading them. Even insurance agents have sometime voiced
this complaint. We have come a long way
to correct the situation. Language has been
simplified, although the contract must still follow legal guidelines. Wording has been standardized, especially as
it relates to insurance and claim terms.
Consumers have been educated so that they are more likely to know what
to expect in a property casualty policy.
The standard fire policy set the stage, so to speak, for many
other forms of insurance. Therefore,
the consumer (and agent) that fully understands this type of policy is more
likely to also understand other types.
The basic concepts of all types of property and liability insurance
originated with the fire policy, primarily the 1943 fire form. There have, of course, been terms added
since then and policy language has changed.
Even so, the basic format remains the same.
There are four basic parts
The fire insurance form has four basic parts to the policy. Those parts are:
1. Declarations
2. Insuring Agreements
3. Conditions
4. Exclusions.
Many policies also have endorsements. Some policies may consider this section to be a fifth part, while
others merely show them as an addition.
Endorsements actually modify one of the four basic parts so
technically they would be an addition and not a fifth part.
Fire policies generally do not specifically identify the four
separate parts. Other types of property
casualty insurance do. Those policies,
such as auto policies, that specifically identify the four parts are easier to
read. However, recognition that the
four parts exist, even if not specifically identified in the policy, is
important to the understanding of how the policy works. Each of the four parts will have what could
be considered subsections. That is,
each part (declarations, insuring agreements, conditions, and exclusions) will
be further broken down in the policy.
The first page of the policy will have some basic facts. The first page is typically called the face page. The heading identifies the insurer
(the company selling the policy) and supplies the location of their home
office. It will also state whether the
insurer is a stock, mutual, or reciprocal company. Following this basic insurer information will be blanks that are
filled in stating the perils covered, the premium charged, and the rate per
$100 of coverage. The amount of insurance issued is the companys maximum
amount of liability.
Declarations
The declarations are made by the insured to the insurer. The person purchasing the insurance is
telling the issuing insurance company specific facts necessary to the issuance
of the policy. This includes the
buyers name, mailing address, location of the insured property, a description
of the property, and the amount of insurance purchased. The standard fire policy reads the
property described hereinafter while located or contained as described in this
policy, or pro rata for five days at each proper place to which any of the
property shall necessarily be removed for preservation from the perils insured
against in this policy, but not elsewhere. Following this statement a paragraph or couple of sentences are
inserted specifically stating the description of the property insured. Should this paragraph that was inserted be
accused of ambiguity when a claim arises, the policy is typically interpreted
in favor of the insured by the courts.
As a result, insurance companies try to be very specific in their
description.
The location of property is a determining factor when setting
premium rates. Some areas experience
more loss in property than do others.
Because premium rates relate to location, policies typically state
exactly where property is insured.
Transferring insured property from one location to another can void the
policy if it is done without the consent of the insurer. The courts distinguish location as either description
or definition of risk. A mere
description error may not alter the policy, but if the location does have risk
attached to it, the policy would be considered altered. If the policy is
altered, it becomes void and the insured may not receive compensation for their
loss.
There is an exception to property movement. If it becomes necessary to remove property
in order to prevent its loss in a fire that is permissible under the policy. The property would be covered pro rata for
five days.
Obviously, the buyer must honestly represent the property to be
insured so that the seller can adequately assess the possible risks
involved. The Standard Fire Policy
requires states that the entire policy is voided if the buyer has purposefully
concealed or misrepresented any material facts or circumstances relevant to the
insurance policy. This is true whether
a claim has been filed or not. The
seller of fire insurance is so absolutely at the mercy of the buyer in the case
of fraud that it is felt a buyer who misrepresents themselves would also
consider arson or other unethical acts.
There is a difference between misrepresentation and
concealment. Misrepresentation is the
changing of facts or risks. Concealment
is the withholding of pertinent information that should have been
revealed. Ethical standards do, of
course, require that all relative information be given when buying
insurance. Courts have ruled that
insurance policies are contracts involving the need for good faith from both
the buyer and the seller. Early court
cases ruled that insurance contracts were based on the chance of loss (risk) so
any withheld information changed the relevance of the possible loss. Therefore, underwriters would be unable to
properly assess the risk and their liability.
When concealment is alleged by insurers the legal test is typically
whether or not the withheld information would have changed the premium rate or
the insurability of the peril. Often
the final decision is made by legal authorities and not the insurance
company. Currently, when it concerns
non-marine insurance, concealment of information that has not been specifically
inquired about does not usually void a policy, unless the concealment is
considered to be fraudulent in nature.
It is surprising the types of fraud insurers have
experienced. Some buyers have actually
misrepresented who they were. In the Haywood
case, the actual insured represented himself under the name of his minor
son. When a fire loss occurred the
insurance company denied the claim because his action was certainly
fraudulent. He had used his sons name
because there were outstanding judgments against him and the policy would not
probably have been granted. He took his
case to court and lost. The court ruled
that knowing the insureds identity is valid when determining risk.
The Insuring Agreements
The Insuring Agreement is a brief and general statement of the
purpose of the contract. It may begin
with words such as in consideration of the provisions and stipulations
herein or added hereto and of the premium specified above . . . It will point out that the consideration
necessary for a binding legal policy contract
involves two things: agreement to the contract provisions and a promise to pay
the premium charged.
Agreement to the policy provisions means
the insured must agree to adhere to the obligations he or she has in the
policy. When it comes to fire
insurance, the insurance company must feel that the insured will take proper
precautions to prevent a fire from happening.
If the insurance buyer takes no precautions at all because they feel the
insurance company will reimburse them anyway it may place more risk on the
insurer than they would be willing to assume.
Therefore, the policy contains considerations that the insured must
take on. The insured must sometimes
adhere to these considerations before the policy becomes valid. For example, he or she may be required to
install fire alarms. There will also be
considerations that must be followed after the policy takes effect. For example, he or she may be required to
keep fire escapes maintained and free of debris. Finally, there will be considerations that are required of the
insured regarding claims. Obviously the
company is not going to pay a claim unless the insured complies with the
requirements of information needed to validate the loss.
Payment of premium is
seldom an issue. Both the buyer and the
seller realizes that the policy must be paid for. The only issue may be at what point the premium was paid. This is usually specifically stated in the
policy. Money does not always have
change hands if credit was assumed. It
is not unusual for credit to be extended when binding a policy.
When is the policy effective?
Every contract has a starting and ending point. Fire insurance policies typically run for a
one-year period. However, this time
period is not in stone. Policies can be
written for one month or for three years, as long as both the buyer and seller
agree to the duration.
It is possible to obtain a perpetual
policy that runs without a time limit, although premiums must
still be paid in some manner. These are
usually paid for by a deposit premium, with no further payment being necessary
unless there is a change in the risk.
Continuing premiums are paid from the investment income earned on the
deposit premium. If the investment
income produces more money than necessary to keep the policy in force, the
excess may be returned to the insured.
If the insurance company cancels this type of policy, the entire deposit
premium would be refunded. If the buyer
cancels the policy it is possible that only 90 percent of the deposit premium
would be returned.
Normally the starting and ending point of a policy is not an
issue. Only when a claim happens on the
borderline will it become one. Many
policies state not only a date of beginning and ending, but a time as well. Commonly policies will state effective dates
such as June 1 at 12:01 a.m. It may
even list such things as time zones or saving time in those states where
daylight saving time applies.
Insurance buyers have won cases even though specific dates were
applied to the policy. If the buyer has
reason to believe that he is covered, and his reasoning is adequately
demonstrated, the insurer may have to pay a borderline claim that is outside of
the time stated on the policy. In such
cases, the acceptance of the risk was considered the beginning date rather than
the date stated on the policy.
The actual delivery date of a policy to the buyer is not
considered legally relevant to the beginning date of coverage. Of course, the buyer should certainly expect
delivery of the policy. Without it, he
or she cannot be certain that the contract represents what they intended to
purchase.
Binders
Binders do not apply to all types of insurance. Many types do not allow an agent to bind a
policy. However, where applicable, when
policies cannot be delivered at once, the representative of the insurer makes
the insurance binding in favor of the insured by issuing what is called a
binder. Binders are a product of the
property casualty field, not necessarily the life and health field. Binders can be either oral or written.
It should be noted that even insurance contracts that have not
actually given the agent authority to bind them have been obligated to pay
claims when the legal system felt it was natural for the buyer to assume the
contract was in effect. As early as
1876, the U.S. Supreme Court recognized the need for oral binders as they
applied to insurance. Even so, binders
are a form of contract and must therefore adhere to all the essential elements
of one. That includes full disclosure
on the part of the insured. Legally,
binders end upon issuance of the policy or at 12:01 a.m. on the next business
day after the risk has been declined by the insurer. Binders are merely a convenience for the buyer and seller.
Since binders may be oral as well as written, what exactly does a
binder look like? In todays business
world, speed has become a requirement.
Some written evidence of insurance coverage may be needed on short
notice. The binder issued will include
identification of who is to be insured, the location and type of property, the
risk that is being insured, the precise time the insurance began, the maximum
length of time the binder is good for (a policy will either be issued or
declined), and a statement of all the terms and conditions that will
apply. Binders and policies are assumed
to have the same initiation date. That
is, the effective date of the binder and policy are assumed to be the
same. The binder is merely a temporary
statement of coverage.
Payment is not necessarily collected with the binder. Premium collection will depend upon various
factors, including the practice of the issuing company. If coverage becomes effective (the risk is
accepted) and no payment has been collected, it is presumed that credit has
been extended and the promise to pay has been made by the buyer. Many companies do not want payment with a
binder because it strengthens the consumers position that they were covered
should a claim arise during this period.
A risk that the company intended to turn down may have to be covered if
money was collected. Since a binder is
issued on the premise that coverage is possible, the consumer would consider
themselves covered regardless of underwriting.
In fact, the binder allows the company to underwrite and determine
whether or not they actually want to insure the risk. If they do, the individual or company was covered from the
effective date of the binder. If the
seller does not want to accept the risk, the binder becomes invalid.
The actual beginning and ending of a policy is often an important
legal point. The claim as it relates to
these dates is equally important. If a
policy expires at 12:01 a.m. and a fire begins at 12:02 a.m. the owner of the
property is not covered. If the fire
begins at 12:00 the entire claim is covered even though the policy expired one
minute later.
Typically a policy continues as long as premiums are paid and as
long as one of the parties does not intentionally cancel the policy. By agreement, fire policies generally do not
specify an ending date, but they do specify a date that premium will again be
due. When the ending date is left blank
it is called an open policy. In marine insurance, nearly 90 percent of
all policies are open policy form. Open
policies may be canceled by either party at any time, usually with a specified
notification period.
Unless the hazards insured change, a policy renewal is typically
a matter of simply paying the premium.
Most policies do state that the policy would become void if the hazards
changed and the insuring company was not notified of the change. Many times, when policies are renewed only
the declarations page is replaced. The
policy itself remains in place as originally printed. The insurer, if there is no substantial change, will simply
furnish a premium notice with the coverage shown in abbreviated form.
Even though the policy does not change, legally a renewal is a
new contract. A new policy is not
issued, though, because the new contract is still based on the same terms and
conditions that were contained in the original policy. The renewal must pertain to the exact same
property originally insured. Any change
or increase in hazards that were not disclosed at the time of renewal will void
the new policy, even if that new policy was only represented by a premium
notice. As each renewal period expires,
the risk also expires and is then renewed by the renewal premium. Any change in the risk must be noted in the
new coverage.
There is equal obligation on the part of the insurer. If any change in the policy renewal is made
part of the policy, they must notify the buyer.
Canceling the policy
Even though each policy is an individual contract, most allow
either party to cancel at any time with appropriate notice. A basic principle of contract law is that
each party must carry out the agreement even if one of them changes their
mind. In other words, the buyer and
seller may only cancel according to the terms of the contract. It may be possible to cancel outside of the
terms for specific reasons, including performance, inability to perform,
bankruptcy, breach, or by mutual agreement.
The contract itself may make specific options for cancellation without
having to name any specific reason for doing so. Unless the policy does make specific options available for
cancellation, the right to cancel does not exist, except by mutual consent.
There are specific reasons why the seller would cancel the policy
after it was issued. While a company
may not cancel due to an approaching claim (that would be fraudulent), they may
cancel because they discover an undesirable moral hazard that was not known
when the policy was issued. After a
suspicious partial loss, the seller may want to remove himself or herself from
further liability before a final settlement of the loss can be made. If a company discontinues certain types of
policies (and the policy in question is one of them), they might exercise their
right to cancel. Whatever the reason,
as long as the seller follows the contract requirements for cancellation, they
may do so without explanation to the insured.
The buyer may also cancel the policy as long as they follow the
procedures outlined in their policy.
Usually the insured may cancel the policy at any time. The cancellation would become effective when
notice of such was received by the company or agent. Generally, neither the
return of the policy nor the return of any unearned premium by the insurer is
necessary to effect cancellation by the insured.
Recently many states have passed legislation that supercedes
contractual agreements regarding cancellation of policies by the insurer. Most of the legislation affects automobile
coverage, but some of it does also affect fire coverage. While there are variances from state to
state, typically the laws provide that after the policy has been in for from 45
to 60 days (depending on the legislation), cancellation can only happen when
there is clear justification, such as fraud or strong evidence of changes in
the insured risks. There are
justifiable reasons in the auto industry.
For example, a driver who has had his or her license suspended or
revoked for driving under the influence would justify cancellation of his or
her insurance. Criminal negligence
resulting in a death could allow the company to cancel their insurance. Any type of action that changed the
liability for the insurer could justify them canceling the policy. Of course, the insuring company must still
follow legally acceptable guidelines when canceling the policy.
As it applies to fire insurance, a conviction of arson would
justify cancellation of the policy.
There has been recent controversy over the practice of canceling or even
denying coverage based on an individuals credit rating. From an insurance standpoint, it is felt
that someone who is a credit risk is more likely to attempt a fraudulent claim
or cause a claim for financial gain.
From a consumers standpoint, refusing auto or fire insurance to them
based on their credit rating is a form of discrimination. Individual states will be addressing this
issue if they have not already done so.
Insurance agents do not like the practice of credit scoring
(using a persons credit rating as an indicator for insurance risk). Agents are frustrated at having to cancel
longtime clients due to their credit history.
Credit scoring is not a new element when establishing risk. Banks and credit card companies have used
credit scores for years to assess their risk when issuing credit. However, agents correctly point out that a
bad history in credit does not mean the individual is a health or driving
risk. While some insurance companies
began the practice as long as twenty years ago, the majority only began using
credit scoring in 1998 and 1999.
Although agents and state insurance commissioners do not like the
practice, according to the Insurance Information Institute (an industry-funded
company), studies have found a strong link between credit ratings and the
likelihood of auto and homeowner losses.
The insurance industry feels that good credit risks should not have to
help shoulder the losses of those that are bad credit risks.
Although many states will be putting legislation in force to
guide these practices, Washington states proposal is one of the strongest so
far. It would stop insurers from using
the absence of a credit history, the number of inquiries to a credit-reporting
agency, and credit problems caused by health care costs in their rate
calculations. Neither will insurance
companies be able to use the purchase of a home or car or a customers total
line of available credit in their calculations.
Larry Kibbee of the Alliance of American Insurers called Washingtons
proposed legislation realistic and the insurance industry has decided to back
the legislation, though they are not totally happy with it.
As of 2002, twenty states are investigating the practice of
credit scoring. Washington is requiring
a year long study before any actual legislation would be passed. It will be 2003 and 2004 before most states
have such legislation in place.
Dealing with credit scoring may be more important than most
consumers realize. We have an
escalating problem with identity theft.
As good credit risks have found, their identity as a good credit risk is
something worth stealing. Although the practice is most often seen in specific
states, it can happen anywhere. When an
identity is stolen, credit is usually taken out using the stolen social
security number and birthdate. With
just those two items, a thief can take out credit cards, buy cars, and rent
apartments. It can be months before the
victim realizes what is happening.
Since a different address is used (usually a mail drop), they will not
be aware until their credit rating is ruined.
Whatever the reason for cancellation it must be done according to
contract language. Although there may
be no clear distinction as to how notice of cancellation may be delivered, insurance companies must be able to show that notice was
received by the insured. If the insured has a claim and can prove that
he or she did not receive the cancellation notice, the insurance company may
still be liable for the claim.
Therefore, companies tend to send notices by registered mail with a
receipt returned to them for proof of delivery. In some cases, the receipt must be signed by the insured or their
legal representative. The 1943 New York
Standard Fire Policy allowed five full days of coverage following the
notification so that the insured could seek coverage elsewhere.
Depending upon the interpretation of the policy, unearned premium
may or may not be returned with the cancellation notice. Some courts have ruled that unless premium
is returned on a pro-rated basis, the policy is still in effect even if notice
of termination has been received. The
1943 New York Standard Fire Policy made three distinctions regarding the return
of unused premium:
The
company giving to the insured five days written notice with or without tender
of the excess of paid premium above the pro rata premium for the expired time
may effect cancellation.
Secondly,
it states that the excess, if not tendered, shall be refunded on demand. In this case, the insured would have to
request the refund of unused premium.
Lastly,
it stipulates that the notice of cancellation shall state that said excess
premium (if not tendered) will be refunded on demand. If there is no excess premium to be
returned, stating the third option does not invalidate the cancellation notice.
When policies are canceled, the refund of unused premium can
appear to be less than would be anticipated.
This lower refund amount is called short-rating. The 1943 New York Standard Fire Policy
stated that when the policy is canceled by the insured, the insurer need only refund
the excess of the paid premium above the customary short rates for the expired
time subject to any minimum retained premium limitations.
Refunding a short amount according to the short rate tables is
justified. Much of the administrative
expenses in running an insurance company happen immediately upon issuing a
policy rather than over the course of the insured period. For example, the cost of underwriting a
policy is incurred immediately at policy issue. Even though premiums may be rated for a 12-month period, the
initial expense has already happened.
Another reason for using short-rating tables has to do with
adverse selection. Adverse selection is
a very real risk for insurers. Adverse selection is the process of
eliminating the best risks, ending up with the worst. The tendency for insurance contract applications to include a
preponderance of poorer than average for the class risks is found throughout
the insurance field, but some areas can be more affected than others. Health insurance especially has to watch out
for adverse selection. The worst risks
will be more apt to apply for insurance coverage because their risk of loss is
the highest. The best risks will be
less likely to apply for coverage because they are least likely to have
claims. For the insurer, this means
that they will be taking on more liability than economically advisable. The rule of insurance is to have a large,
safely diversified, profitable group of risks.
A reason for using short-rating tables is to offset the possibility of
adverse selection. Most types of risk
are not even throughout the year. The
majority of house fires, for example, happen during the cold months. If a consumer knew this, they might only buy
insurance during the winter months, letting it lapse during the summer
months. Those who buy health insurance
might only purchase such coverage prior to certain events (if such events could
be predicted). Using short-rating helps
companies to offset this possibility.
Even though our current policies have been updated in its
language to become more consumer friendly, cancellation provisions have
remained fairly constant. Short-rating
is still used, but in a different manner.
Todays policies often state a percentage. For example, the policy may state: If the named insured cancels
the policy, the return premium shall be ninety percent of the unearned premium
computed on a pro rata basis. Even
though this is still short-rating, it gives the buyer a precise knowledge of
what to expect.
What are the principle concepts of insurance?
Reading an insurance policy means the reader must have some idea
of the concepts under which insurance works.
Otherwise, understanding the policy would be difficult. Not everyone agrees that insurance works on
principles, but those in the industry know that principles are part of the
business.
INDEMNITY
A major principle of insurance is that of indemnity. Indemnity means reimbursement for an actual financial loss. Insurance cannot replace any loss that is
not financial in nature, although some types of policies may claim to do
so. Peace of mind really means financial
peace of mind. If our spouse must go
into a nursing home, long-term care insurance can pay the cost, but it cannot
bring peace of mind. The person is
still in the nursing home whether they want to be or not.
The idea that every insurance policy is about replacing financial
loss is not agreeable to many people.
In fact, it may not be agreeable to many insurance agents. Obviously, life insurance cannot replace the
person that has died. It can only
replace the financial security that person brought to their family. The idea of placing a dollar value on
someone we love is not socially acceptable and yet, that is what life insurance
does.
Liability insurance presents a different twist on indemnity. These policies pay (on behalf of the
insured) claims for which the insured has become legally obligated. The key words here are legally
obligated. The insured need not
agree to the reason the insurance is paying.
The insurer typically makes the payment directly to the claimant, so
there is no way for the insured defendant to see any financial gain as a
result. When the individual is found
legally liable to the claimant, the decision is never based on whether or not
liability insurance is in place. Even
if no insurance exists, the person is still legally liable to the
claimant. Insurance or no insurance is
merely an indication of whether the insurance company will pay or the person
themselves must pay the claimant. Even
though the insured will not personally see the insurance payment, since they
would otherwise be personally liable, they may still be considered as
indemnified for that loss.
There are two primary purposes in the principle of
indemnity. (1) By limiting the payment
to the loss sustained, the insured individual is not going to personally gain
anything. If the person could financially
gain, insurance would simply be a gamble of winning or losing. (2) If a person could gain financially from
the loss, the probability of a loss would certainly go up. Obviously fraudulent acts would greatly
increase and the cost of insurance would follow. Eventually, the industry would not be able to continue.
INSURABLE
INTEREST
Insurance agents, especially in the life field, work with
insurable interests in every contract.
Exactly what is considered an insurable interest can depend upon the
contract and the definition it has applied.
As it relates to the property and liability field, it is every interest
in property or potential loss of assets arising from a legal liability of such
a nature that a contemplated peril may lead to an economic loss for the
insured. A common insurable interest
would be a company that leased equipment to a business. The leasing company has an insurable
interest because their equipment is located at the business address.
Insurable interests typically include ownership or possession,
liability or bailee interests, creditors where a debt is ongoing, contractual
interests, and expectation. Obviously,
the insurable interest must be a legal interest. Those with the insurable interest do not necessarily have a legal
or equitable title to the property. The
party would have the expectation of profit or benefit in some way from the
subject of interest. Like the concept
of indemnity, the concept of insurable interest includes the idea of limiting
the amount of recovery to the actual loss sustained. [1]
Some insurable interests are obvious. The company that holds the mortgage to our home obviously has an
interest in the property. The legal
system fully recognizes this insurable interest. Both the mortgage company and the homebuyer may insure the
property. However, how they insure the
property may differ. The mortgage
company may insure the property to the limits of their interest in it (the
amount owed to them), while the homebuyer may insure the property to the extent
of its value or expected value. Each
party may insure the property without notifying the other. The courts hold that in a case such as this,
each party may secure insurance without consulting the other and without giving
notice to the other. Since each pays
their own premium, the other party is considered a stranger to the transaction
so has no claim on any proceeds that might result from a loss.
As we know, mortgage companies generally require that the
homebuyer carry insurance and pay the premiums for that insurance. If the homebuyer fails to do this, the
mortgage company may (if the contract so states) purchase the insurance on
their behalf and charge the premium to the homebuyer. This may also be the case on automobile loans financed through
banking institutions. The policy is
intended to protect the lending company.
If the home burns down or otherwise sustains a loss that might threaten
the lenders ability to collect what is owed them, the insurance policy would
pay off the outstanding balance before making any payment to the homebuyer.
For Example:
Bob and Martha bought their home for $150,000. That is the amount they borrowed from their
bank, so that is the amount they must pay off over the next thirty years. They insure their home for its true assessed
value of $175,000. Unfortunately the
home burns down one year later and is a total loss. Their insurance first pays the lender the balance owed them and
then pays the difference to Bob and Martha.
Therefore, Bob and Martha do not receive $175,000. They receive the difference between that
figure and $150,000 or approximately $25,000.
Most homes are not total losses.
Most fires only partially destroy the structure. In that case, the insurance would repair the
damage and Bob and Martha would continue to pay their lender for the home over
the thirty-year period.
Whenever possible, insurance companies prefer to issue a policy
in the name of the homebuyer and then to join the two interests. Doing so reduces the possibility of fraud
and eliminates complications that can happen when two interests exist in the
same piece of property.
There are several ways to assign insurable interests. These include:
As
previously stated, the interests of the
homebuyer and lender may be joined in one policy.
The policy may contain a provision, such
as found in the New York Standard Fire Policy, providing for 10 days notice to
the lender before the policy is canceled.
The lender may make a claim under the policy if the buyer fails to do
so.
The policy may be assigned to the
lender with the consent of the insurer. This method, like the joined interest method, allows the buyer to
receive any excess claim funds after the lender is paid. If the homebuyer violates the terms of the
policy, however, the lender could find themselves unprotected. In addition, since the lender is not a
contracting party, they have no legal rights with respect to participation in
any negotiations after a loss. Most
lenders consider this method unsuitable because they do not retain control of
the property.
The policy may be assigned without
consent of the insurer. This means
the policy may be pledged as collateral security without the consent of the
insurance company.
The policy may be endorsed by a
loss-payable clause. There is
some legal confusion regarding this method but if it is correctly set up, it
can be an excellent avenue for the lender.
Since the lender is not bound by the conditions of the policy, the acts
of the homebuyer cannot be set up as a defense against the lender even though
they possess all the rights of the mortgagor.
This loss-payable clause is widely used when personal property is given
as security for a loan. Auto loans
especially use this form taken from the fire insurance mortgage clause.
The policy may be endorsed by a
mortgage clause. Like the
first method, it joins the interests of both the lender and the buyer. In this method, however, a special clause is
endorsed in the contract itself. This
is the form most widely used by lenders.
Using the Mortgage Clause
The mortgage clause joins two interests: those of the lender and
buyer. Since it is necessary to protect
the interests of the mortgagee (lender) against forfeiture of the policy due to
acts of negligence by the buyer a mortgage clause is used. The buyer takes out a policy in his or her
name, but a special clause is endorsed on the contract. The insurer agrees to protect the interests
of the lender regardless of any acts of negligence on the part of the
buyer. The clause may be part of the
form (as it is on the Homeowners forms and the Dwelling Policy Program) or it
may be attached to the policy as a separate endorsement.
Fire policies often have large sections devoted to the mortgage
clause. There is good reason this type
is so widely used. By indorsing the
mortgage clause on the buyers policy, the insurer is specifically protecting
the lender by giving them legal rights in the coverage. In only a few states where the loss-payable
clause has been interpreted as an independent and unconditional agreement
between the lender and the insurance company does it provide better coverage
for the lender than would be given under the mortgage clause method. Consequently, the loss-payable method would
be used in those cases.
When a loss occurs, insurers typically make out a joint draft to
both the lender and the buyer. Release
from both parties is obtained when the draft is endorsed and cashed.
When negligence or neglect is a factor
The Mortgage Clause stipulates that the insurance is not voided
by the buyers acts of neglect.
However, when the mortgagor is guilty of misrepresentation of the facts
prior to the issuance of the policy, or if he or she has purposely concealed
relevant information in the insurance application, the policy may be open to
invalidation. The lender may be
protected as long as they upheld their responsibilities. The mortgage clause requires the lender to
notify them of any change of ownership or occupancy, or increase of any type of
hazard that they might be aware of.
They would also be required to notify the insurer of any knowledge of
concealment of information or misrepresentation of facts on the application for
insurance.
Lenders
Responsibility:
In the mortgage clause it will state that the lender will be
required to pay the premiums if the buyer does not. Although the lender cannot be held liable for the premiums, if
they are not paid, the policy will lapse and the mortgagee will have no
protection.
The mortgage clause also states that the lender (mortgagee) or
trustee must notify the issuing insurance company of any change of ownership or
occupancy or increased hazard relating to the property. It also gives the insurer the right to
increase premium cost due to any changes.
If the insurer cancels the policy under the terms of the
contract, it must still give the lender ten days notice so that they may seek
other insurance coverage. Cancellation
can occur in two ways: by cancellation of the policy itself, or by cancellation
of the mortgagee clause. Either way,
the ten days still apply. In some
states or in some situations, the insurer must give the lender up to 30 days
notice. The exception to this would be
nonpayment of the premium, which typically requires only five days notice under
the terms of the Standard Fire Policy.
Proportional Payments
Although it is not generally recommended to over-insure, there
are occasions when more than one policy on the same property exists. The Standard Fire Policy stipulates that
each insuring company will pay only that part of the loss that is represented
by the proportion that its policy bears in relation to the total insurance
granted under all combined policies.
This will probably not make for a happy client. Unfortunately, the insured often believes
that each policy will pay fully allowing him or her to make a profit. Insurance is not designed for profit. It is designed to merely pay the specific
loss and not a penny more.
There have been court cases that made exception to the standard
rule that refused profit from insurance policies. However, these court cases involved policies taken out
independently of each other and were purchased as a specific protection for a
lender. As a result of these court
cases, it has become common to add a contribution clause to the mortgage
clause. Therefore, there are two forms
of standard mortgage clauses used. One
is called the non-contribution mortgage clause and the other is called the
full-contribution mortgage clause. The
full-contribution clause adds the following:
In case of any other insurance upon the within described property
this company shall not be liable under this policy for a greater proportion of
any loss or damage sustained than the sum hereby insured bears to the whole
amount of insurance on said property, issued to or held by any party or parties
having an insurable interest therein, whether as owner, mortgagee, or
otherwise.
Although the intent of this addition was to avoid misunderstandings,
there have still been conflicting court decisions regarding it. Perhaps the joke about insurance is correct:
it takes one attorney to write the policy, a second attorney to dispute its
meaning, and a third attorney to decide who is right.
When more than one mortgage exists
In this day of equity offerings all over television it is common
for individuals to take out a second mortgage, usually referred to as an equity
loan. In fact, it is now possible to take
out a second mortgage that makes the total due add up to more than the value of
the home. Equity loans that allow
greater amounts to be borrowed than actually exists in equity are seldom a good
financial move. The interest charged is
nearly always higher when the equity borrowed against does not equal the loan
amount.
When second and even third mortgages exist on the same home, the
insurance solutions are seldom uniform.
The homebuyer may not realize all their options, sometimes not even insuring
the second and third equity loan. It is
possible to incorporate the standard mortgage clause in the name of the first
lender, attaching a loss-payable clause for the equity loans. This would give the second lender less
protection than the first. If there is
a third lender, they would receive even less protection than the second.
Another option is to use one standard mortgage clause and list
all the lenders involved, giving each protection under the policy. However, the first lender may veto this option
feeling that they could be short-changed in the event of a loss.
A third option would be a separate policy for each lender. If this avenue were chosen, the question of
contribution could be an issue, however, following a loss.
When one policy is used for all lenders, the proceeds are divided
in proportion to their claims.