As someone who writes prolifically about real estate and insurance, this article, as compared to others I have written, is relatively short, however, given some of the recent conversations I have had with investors and some of the recent classes I have taught, I feel it is necessary.
Unfortunately, insurance as a whole is normally viewed by consumers as a commodity or a ‘necessary evil’ that must be obtained when purchasing property and it is usually quoted and purchased with little or no actual knowledge of the policy itself on either the part of the buyer or even the agent providing it.
Because of this, as well as the nature of insurance law, the lack of professional knowledge had by many agents, and the many confusing semantics used within the insurance industry, there is a great deal of confusion between such terms as “Additional Insured”, “Additional Interest”, “Mortgagee”, “Loss Payee”, and “Named Insured” and they are used interchangeably as if they all mean the same thing – BUT THEY DON’T! Unfortunately, this confusion can result in unintended financial loss and unnecessary litigation far into the future and long after the policy has been first issued. All it takes is one claim or loss for the parties in the policy to find out how they really are, or are not, protected and that words actually matter.
For example, when working with investors and non-standard types of insurance situations, it is inevitable that the party requesting the insurance coverage asks to have someone else (usually the seller in a seller-financed transaction) inappropriately listed as an “Additional Insured” on the policy without understanding what he or she is really asking for. What the purchaser (and “Additional Insured Party”) fails to realize is that this provides absolutely no protection whatsoever for the party listed as the “Additional Insured” with regards to the physical property in the event of a physical or financial loss.
The purpose of this article is to finally, in real-life language, explain the difference in these terms so that you, the real estate professional and/or investor, are able to appropriately protect yourself and your interest in any property being insured, whether via wrap-around mortgage, traditional lending, or any other purchase scenario.
The term “Named Insured” refers to the owner of the insurance policy and it is the party listed on the Declaration’s Page. The “Named Insured” is the only party that has authority to make any policy changes, file claims, receive refunds and claim payments, cancel the policy, or make any other such modifications.
In addition, the Named Insured MUST have a primary insurable interest in the property and be the titled owner.
This is probably the single most misunderstood insurance term that is misused and misapplied on a regular basis. An “Additional Insured” is a party listed on an insurance policy that has some type of liability interest in the property. The “Additional Insured” has absolutely no right or authority to make any policy changes or to cancel the policy. Also, contrary to popular belief, an “Additional Insured” is ONLY afforded liability protection under the liability portion of the policy and there is no coverage whatsoever for physical losses resulting from such things as vandalism, theft, fire, wind and hail, and so on.
For example, with regards to residential property, if a property were seller-financed and the seller was actually carrying back a mortgage note and they were listed as an “Additional Insured” on the policy instead of as a mortgagee (described further below), then in the event of a physical loss (the home burned to the ground), the seller would have absolutely no legal right whatsoever under the policy to receive claim funds to pay off the mortgage debt and/or there would be no control of managing claim funds to ensure repairs.
However, if there was litigation involving the property or its use and the “Additional Insured” was named in the suit for any reason, the policy provides liability protection for legal and defense costs for the “Additional Insured” and the insurance company issuing the coverage would have a ‘duty to defend’ any and all “Additional Insured parties” listed in the policy. The most common example of this actually involves commercial policies, such as general liability, whereby a general contractor, for instance, may be listed as an “Additional Insured” on a subcontractor’s insurance so that in the event of a liability claim caused by the subcontractor (such as faulty work, property damage, or bodily injury) where the general contractor is also listed in the suit or claim, he or she receives coverage for legal and defense costs from the subcontractor’s policy.
Many buyers and sellers in a wrap-around mortgage transaction prefer to have the seller listed as an “Additional Insured” rather than as a “Mortgagee” simply because they don’t want to blatantly alert the underlying lender that there has been a transfer of the property. The unintended consequence of this, however, is that the coverages and protections afforded to the seller (who is technically a second mortgagee) are greatly reduced and limited now to liability protection only.
An “Additional Interest” is nothing like the “Additional Insured” though they sound similar. An “Additional Interest” is a party listed in an insurance policy that has an “interest” in being notified whenever a policy cancels or has a major change made to it. In other words, this party is simply being made aware of the change – nothing else. There is absolutely no coverage whatsoever afforded to an Additional Interest. An example of a party who may need to be listed as an “Additional Interest” is a loan servicing company who is managing the loan for a seller-financed transaction. The servicing company has no insurable interest in the property and has no coverage under the terms of the policy, but it does have an interest in being notified if or when the policy is canceled so that it may contact the mortgagee and either have the policy reinstated or request updated proof of any new replacement policy.
It is important to understand that Mortgaee’s and Additional Insured’s automatically get notifications of all policy cancellations and/or major changes and that only other parties associated with the loan in some capacity (but have no insurable interest) should be listed as “Additional Interests”.
The “Loss Payee” is another very misunderstood term which is most often associated with automobile loans – though it is very applicable to commercial and residential property as well. In regards to insurance, a “Loss Payee” (which automatically includes any mortgagee) is the party (or parties) to which any payment being made under the policy in relation to a claim or loss will be made before being released directly to the Named Insured.
For example, assume that you own a property for which “XYZ Bank” is the mortgagee. A kitchen fire occurs in this property and a claim is filed for the damage, which is estimated to be at $85,000. When the insurance company releases the $85,000 claim check, it should be made out to both you (the Named Insured policy owner) as well as XYZ Bank (as the mortgagee and loss payee). This means that XYZ Bank must verify the claim and then endorse the check over to you – or the contractors performing repairs – before it may be cashed. The reason for this is simple; XYZ Bank has a financial interest in the property via the mortgage loan and they want to make certain that they maintain control of the loss payment to ensure that the loan is either paid off (in the event that repairs are not performed) or that the money does in fact go towards repairing the property that is collateralizing their loan – and not to paying for your upcoming ‘around the world’ vacation.
So far we have described the difference between an Named Insured, Additional Insured, Additional Interest, and a Loss Payee; now let’s discuss the true meaning of what a “Mortgagee” really is.
A “Mortgagee” is the entity that actually originates and holds the Promissory Note and Mortgage loan on real property; otherwise known as the bank or the mortgage lender. The Mortgagee extends financing to the “Mortgagor” – who is the homeowner or borrower in the transaction.
By default, all Mortgagees listed in an insurance policy are also automatically considered as “Loss Payees”, meaning that, as in the section above, any claim payments should theoretically be made to both the Named Insured as well as every Mortgagee listed. If a party who has made a mortgage loan to the Named Insured is not listed in the policy, whether intentionally or unintentionally, then that Mortgagee will not be afforded any rights or coverages under the terms of the policy itself.
As you can see, there is a big legal difference between these terms and having an interest listed incorrectly can have unintended and far-reaching consequences in the event of a loss, default, or other such situation. Your agent should know the difference between these five terms, however, the reality is that the vast majority of licensed agents are salespeople with quotas to meet and they seldom, if ever, deal with investor-related transactions and therefore often don’t know the difference between these coverage position themselves. If you have any questions or would like to discuss your own insurance needs, please feel free to call us at (800) 299-8994 or email us at email@example.com
As an investor and insurance broker working with investors, I have property owners contact me on a regular basis stating that they ‘need’ to purchase a dwelling insurance policy in the name of their LLC for their rental property. When I tell them that what they want really isn’t possible and that the policy has to be issued in their name personally, they become very defensive and irate, and insist that I don’t understand what they are asking for. I normally try to again explain how the property should actually be insured, but I am almost always cut-off with the words “I don’t think you understand, the property is in the name of my LLC, not my name personally.” Few people are able to comprehend the fact that the property being titled in the name of a company or LLC has little or nothing to do with the actual coverage provided by the insurance policy itself – but it DOES dictate how the policy must be issued and what company will issue it. Unfortunately, I’ve become very accustomed to this. They also can’t understand why they often need to provide their social security number and date of birth.
The problem here is that these property owners don’t really have any idea what they are asking for and they are ‘demanding’ something that doesn’t really exist (more on that in the next few paragraphs.)
Before we go too far, there are some important concepts that you must first understand with regards to insurance contracts in order to better understand why it not usually possible to issue a policy like this in the name of an LLC.
THE BASIC PURPOSE OF USING AN LLC
What many owners and investors fail to realize is that placing the property in the name of an LLC or Trust really doesn’t have anything to do with insurance whatsoever – it is a strategy to allow anonymity (although not as good as a Trust), minimize personal legal liability exposure, and have the ability to take advantage of various real-estate related tax deductions. It really doesn’t do anything from an insurance standpoint except dictate the manner in which the policy has to be issued. However, few people actually understand the nature of property and casualty insurance contracts and they, therefore, assume that the policy must be in the name of the same LLC that has legal title to the property. This simply isn’t so.
The basic reason for putting a property in the name of an LLC is simple. If a property is titled in the name of an LLC and there is a litigation involving the property, the Plaintiff, under normal circumstances, can only sue and seek damages from the assets of the LLC itself – which aside from the property (which usually has a first-lien mortgagee) are minimal. In theory, this protects the individual owner’s personal assets from being attached to the suit and liquidated for damage awards if the Plaintiff wins the suit. Of course there are situations in which the LLC is voided by the court, such as in cases of gross neglect, when the LLC documentation has not been properly created, or when the LLC is considered null because of the owner/member’s failure to maintain a minute book and similar, but those are all legal issues having nothing whatsoever to do with insurance.
THE PROBLEM WITH INSURING RESIDENTIAL PROPERTY IN AN LLC
To begin with, a dwelling policy, which is the type of policy used to insure one and two-unit residential rental property, is a personal insurance product. In other words, it is a type of personal insurance policy – just like an automobile or homeowner’s policy. An LLC is a corporate entity. Therein lies the rub. You can’t issue a personal policy for property titled in a corporate or company name any more than you can insure a 20-story office building on a personal homeowner’s policy. They are mutually-exclusive.
From a physical standpoint, it’s still the same building with the same tenants and the same rent – and from the point of view of the investor/owner – the risk hasn’t changed and it’s “silly” that an insurance company won’t issue the policy in the name of the LLC. However, from the insurance company’s perspective (and they are the ones assuming the risk and issuing the policy), even though the building itself maybe the same, the liability nature of the risk has changed in that it is now a commercially-owned property. This is the same situation that would exist if you opened a new courier business (ie: ABC Couriers) and took your personal ‘daily driver’ vehicle and transferred the title to your new company. The vehicle would still be the same with no physical change, but it would be owned by “ABC Couriers” (no longer you personally) and you would be required to purchase a commercial automobile policy since your previous personal auto policy does not generally cover vehicles legally owned by or titled in the name of a business.
Furthermore, when insurance companies provide quotes for personal insurance (including dwelling policies), they must first verify the actual risk that they are potentially insuring – which is why they almost always require a social security number, date of birth, and/or other personal information. This information is almost always required except for those few companies that do not use credit scoring and which only issue very basic and very minimal coverage or those companies which will issue coverage without this information (though the ‘base premium rate’ is automatically higher from the start when this information isn’t provided). Insurers use this information to search for previous claims and losses, prior lapsed insurance, and to assist in developing an insurance score for the party requesting the new coverage. However, LLC’s don’t have a social security number, they don’t have a date of birth, and the insurers issuing the coverage have no way of verifying past insurance history.
In addition, most insurance companies clearly state in the guidelines and eligibility requirements for dwelling policies that an LLC cannot, under any circumstances, be a ‘named insured’ on any dwelling policy for the reasons already mentioned.
Again, an LLC is a legal corporate entity that cannot normally be used to purchase a personal insurance policy regardless of what the property owner has been told by other parties or what he or she ‘wants’. If the property owner absolutely insists that the insurance be in the name of an LLC, there are only a couple of options available; either issue a policy with a non-standard or surplus-lines company that will allow this (which usually results in a lesser-quality policy with fewer coverages) or issue a commercial policy. Both options are more expensive and neither is an ideal way to insure the property.
HOW TO INSURE PROPERTY TITLED IN THE NAME OF AN LLC
There are really only three ways to issue a dwelling policy for property titled in the name of an LLC, and these are really dictated by the eligibility guidelines of the insurance company issuing the policy itself, not the agent, broker, or property owner.
# 1 – Individual as Policy Owner and LLC as Additional Insured
The first, and best, method of insuring a property like this is to issue the policy in the name of the individual owner (since he or she is the managing member of the LLC) and then list the LLC as an Additional Insured. This is normally the only way to issue coverage with a ‘standard’ insurance company which provides better coverage and lower premiums. In the event of a claim, the policy owner (who also owns or is a member of the LLC) can file and manage the claim, receive claim payments, make policy changes, and so on.
In this situation, the policy must be issued in the name of an individual (ie: ‘Named Insured’) who is a member of the LLC, normally the managing member. The reason for this is because the insurer must have a social security number, date of birth, and other personal data in order to develop and insurance score and verify past claims history (remember, LLC’s don’t have this!). The LLC (which has an ‘insurable interest’ because of the legal title) is then listed as an ‘Additional Insured’ party so that it is afforded liability coverage under the policy.
In the event that there is litigation involving the property, such as a tenant suing for injuries sustained due to the property’s maintenance condition, the insurance company has a ‘duty to defend’ the named insured (individual listed on the policy) as well as the LLC since it is listed as an ‘Additional Insured’. The liability portion of the policy will pay for legal, defense, and/or any settlement costs resulting from the claim or loss. Both the individual and LLC are covered.
# 2 – Non-Standard Policy in name of LLC
As an exception to method #1 above, there are only a few (only one or two) standard companies that will issue a policy with the LLC actually being listed as the ‘Named Insured’ policy owner. The catch to these few companies is that (a) they are more expensive than others (b) they charge an ‘endorsement surcharge’ in addition to the regular premium for having the LLC as the named insured, (c) they normally have at least a minimum 2% deductible requirement, and (d) they won’t insure properties over 20 years of age. Because of these four items, this normally isn’t an option.
If, for whatever reason, the property insurance must absolutely and positively be in the name of the LLC (and from an insurance perspective there really isn’t one), then the second option is to issue coverage through a non-standard ‘surplus lines’ company (such as Lloyd’s of London). These insurance carriers are normally very financially secure, however, they operate under a different set of state insurance codes and laws than do ‘admitted’ or standard companies, which means that they can write their own policies with endorsements, coverages, and exclusions tailored specifically for the individual risk or property being insured. One of the biggest concerns here is that the cost of the policy is almost always (100% of the time) much more expensive than a ‘standard’ company. There is also a 25% ‘minimum earned premium’ due as soon as the coverage is issued and these companies must also charge state taxes along with various fees, which can sometimes total hundreds of dollars. In addition, they usually offer less coverage and they use third-party claims services to manage losses – which often creates a disappointing claims process for the policy owner.
This is an option, but it’s not the first choice.
#3 – Commercial Policy in Name of LLC
The last option, which is also not recommended, is to insure the property with a commercial policy with the LLC as the policy owner. Again, there are issues with this as well. First of all, depending on the characteristics of the property, this normally has to be done in the non-standard or ‘surplus lines’ market mentioned above – which means more premium. Secondly, many of these companies simply won’t issue commercial coverage on a residential property with habitational exposure. Finally, if a company is willing to issue a commercial policy in the name of the LLC for a residential property, the premium itself will be so cost-prohibitive that there is no point in purchasing the policy.
In summary, LLC’s are excellent corporate entities for the purposes of taxation and reducing liability, but they are often misunderstood and misapplied to insuring residential property and many investors and property owners spend a great deal of time and effort debating and worrying about a fairly irrelavent non-issue. Should you have questions, please feel free to contact us at (800) 299-8994 and we will be happy to answer any questions that you may have.